##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark one)

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

For the quarterly period ended March 31, 2007

OR



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

For the transition period from to
.

Commission File Number: 0-27696



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GENSYM CORPORATION

(Exact name of registrant as specified in its charter)



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

52 Second Avenue

Burlington, MA 01803

(Address of principal executive offices)

Telephone Number (781) 265-7100

(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 ̈

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of
the Exchange Act. (Check one):

Large Accelerated Filer ̈Accelerated Filer ̈Non-accelerated
filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).    Yes ̈No  x

As of July 10, 2007 there were 7,922,404 shares of the Registrants Common Stock outstanding.



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##### Table of Contents

INDEX



|                             |  |                                                                                                      |  |   
|---------------------------- |  | ---------------------------------------------------------------------------------------------------- |  | --
|Part IFinancial Information |  |                                                                                                     
|                             |  |                                                                                                     
|Item 1.                      |  | Consolidated Financial Statements                                                                    |  |   
|                             |  |                                                                                                     
|                             |  | Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006 (Unaudited)                   |  | 3 
|                             |  |                                                                                                     
|                             |  | Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006 (Unaudited) |  | 4 
|                             |  |                                                                                                     
|                             |  | Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006 (Unaudited) |  | 5 
|                             |  |                                                                                                     
|                             |  | Notes to Consolidated Financial Statements                                                           |  | 6 
|                             |  |                                                                                                     
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                |  | 10
|                             |  |                                                                                                     
|Item 3.                      |  | Qualitative and Quantitative Disclosures About Market Risk Investment Portfolio                      |  | 16
|                             |  |                                                                                                     
|Item 4.                      |  | Controls and Procedures                                                                              |  | 16
|                             | 
|Part IIOther Information    |  |                                                                                                     
|                             |  |                                                                                                     
|Item 1.                      |  | Legal Proceedings                                                                                    |  | 18
|                             |  |                                                                                                     
|Item 1A.                     |  | Risk Factors                                                                                         |  | 18
|                             |  |                                                                                                     
|Item 2.                      |  | Unregistered Sales of Equity Securities and Use of Proceeds.                                         |  | 24
|                             |  |                                                                                                     
|Item 6.                      |  | Exhibits                                                                                             |  | 26
|                             |  |                                                                                                     
|                             |  | Signatures                                                                                           |  | 27
|                             |  |                                                                                                     
|                             |  | Exhibit Index                                                                                        |  | 28



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. | Consolidated Financial Statements
|------- | ---------------------------------

GENSYM CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share amounts)



|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                        |  | March 31, 2007 |         |   | December 31, 2006 |  
|ASSETS                                                                                                                                                                                                  |  |                |         |   |                   |   |         |  
|Current Assets:                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                                                               |  | $              | 3,178   |   |                   | $ | 3,238   |  
|Accounts receivable, net of allowance for doubtful accounts of $42 at March 31, 2007 and $47 at December 31, 2006                                                                                       |  |                | 3,009   |   |                   |   | 2,952   |  
|Prepaid and other current assets                                                                                                                                                                        |  |                | 406     |   |                   |   | 453     |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total current assets                                                                                                                                                                                    |  |                | 6,593   |   |                   |   | 6,643   |  
|Property and equipment, net                                                                                                                                                                             |  |                | 519     |   |                   |   | 561     |  
|Deposits and other assets                                                                                                                                                                               |  |                | 124     |   |                   |   | 132     |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total Assets                                                                                                                                                                                            |  | $              | 7,236   |   |                   | $ | 7,336   |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|                                                                                                                                                                                                        |  |               
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|Current Liabilities:                                                                                                                                                                                    |  |                |         |   |                   |   |         |  
|Accounts payable                                                                                                                                                                                        |  | $              | 622     |   |                   | $ | 500     |  
|Accrued expenses                                                                                                                                                                                        |  |                | 1,515   |   |                   |   | 1,855   |  
|Current portion of capital lease obligation                                                                                                                                                             |  |                | 108     |   |                   |   | 113     |  
|Deferred revenue                                                                                                                                                                                        |  |                | 4,379   |   |                   |   | 4,323   |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                                                               |  |                | 6,624   |   |                   |   | 6,791   |  
|                                                                                                                                                                                                        |  |               
|Capital lease and other long term liabilities, net of current portion                                                                                                                                   |  |                | 185     |   |                   |   | 181     |  
|Long term deferred revenue                                                                                                                                                                              |  |                | 691     |   |                   |   | 826     |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total Liabilities                                                                                                                                                                                       |  |                | 7,500   |   |                   |   | 7,798   |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Commitments and contingencies                                                                                                                                                                           |  |                |         |   |                   |   |         |  
|Stockholders Deficit:                                                                                                                                                                                  |  |                |         |   |                   |   |         |  
|Preferred stock $.01 par value-authorized 2,000,000 shares issued and outstandingnone                                                                                                                  |  |                |         |   |                   |   |         |  
|Common stock $.01 par valueauthorized20,000,000 shares issued8,210,773 and 8,210,441 shares in 2007 and 2006 respectively,
outstanding7,878,404 and 7,878,072 shares in 2007 and 2006, respectively |  |                | 82      |   |                   |   | 82      |  
|Capital in excess of par value                                                                                                                                                                          |  |                | 22,695  |   |                   |   | 22,686  |  
|Treasury stock332,369 shares in 2007 and 2006 at cost respectively                                                                                                                                     |  |                | (1,240  | ) |                   |   | (1,240  | )
|Accumulated deficit                                                                                                                                                                                     |  |                | (21,852 | ) |                   |   | (22,031 | )
|Accumulated other comprehensive income                                                                                                                                                                  |  |                | 51      |   |                   |   | 41      |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total stockholders deficit                                                                                                                                                                             |  |                | (264    | ) |                   |   | (462    | )
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  
|Total liabilities and stockholders deficit                                                                                                                                                             |  | $              | 7,236   |   |                   | $ | 7,336   |  
|                                                                                                                                                                                                        |  |                |         |   |                   |   |         |  

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements



3



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##### Table of Contents

GENSYM CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share
amounts)



|                                                   |  |                             |       |      |   |       |  
|-------------------------------------------------- |  | --------------------------- | ----- | ---- | - | ----- | -
|                                                   |  | Three Months EndedMarch 31, |      
|                                                   |  | 2007                        |       | 2006 |  
|Revenues:                                          |  |                             |       |      |   |       |  
|Product                                            |  | $                           | 1,605 |      | $ | 1,692 |  
|Services                                           |  |                             | 2,488 |      |   | 2,196 |  
|                                                   |  |                             |       |      |   |       |  
|Total revenues                                     |  |                             | 4,093 |      |   | 3,888 |  
|                                                   |  |                             |       |      |   |       |  
|Cost of revenues:                                  |  |                             |       |      |   |       |  
|Product                                            |  |                             | 117   |      |   | 131   |  
|Services                                           |  |                             | 1,125 |      |   | 858   |  
|                                                   |  |                             |       |      |   |       |  
|Total cost of revenues                             |  |                             | 1,242 |      |   | 989   |  
|                                                   |  |                             |       |      |   |       |  
|Gross profit                                       |  |                             | 2,851 |      |   | 2,899 |  
|                                                   |  |                             |       |      |   |       |  
|Operating expenses:                                |  |                             |       |      |   |       |  
|Sales and marketing                                |  |                             | 710   |      |   | 1,304 |  
|Research and development                           |  |                             | 672   |      |   | 961   |  
|General and administrative                         |  |                             | 1,224 |      |   | 1,097 |  
|                                                   |  |                             |       |      |   |       |  
|Total operating expenses                           |  |                             | 2,606 |      |   | 3,362 |  
|                                                   |  |                             |       |      |   |       |  
|Operating income (loss)                            |  |                             | 245   |      |   | (463  | )
|Other expense, net                                 |  |                             | 11    |      |   | 8     |  
|                                                   |  |                             |       |      |   |       |  
|Income (loss) before provision for income taxes    |  |                             | 234   |      |   | (471  | )
|Provision for income taxes                         |  |                             | 55    |      |   | 2     |  
|                                                   |  |                             |       |      |   |       |  
|                                                   |  |                            
|Net income (loss)                                  |  | $                           | 179   |      | $ | (473  | )
|                                                   |  |                             |       |      |   |       |  
|Basic income (loss) per share                      |  | $                           | 0.02  |      | $ | (0.06 | )
|Diluted income (loss) per share                    |  | $                           | 0.02  |      | $ | (0.06 | )
|                                                   |  |                            
|Basic weighted average common shares outstanding   |  |                             | 7,878 |      |   | 7,437 |  
|Diluted weighted average common shares outstanding |  |                             | 8,052 |      |   | 7,437 |  

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements



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GENSYM CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



|                                                                                         |  |                             |       |   |      |   |       |  
|---------------------------------------------------------------------------------------- |  | --------------------------- | ----- | - | ---- | - | ----- | -
|                                                                                         |  | Three Months EndedMarch 31, |      
|                                                                                         |  | 2007                        |       |   | 2006 |  
|Cash Flows from Operating Activities:                                                    |  |                             |       |   |      |   |       |  
|Net income (loss)                                                                        |  | $                           | 179   |   |      | $ | (473  | )
|Adjustments to reconcile net (loss) income to net cash provided by operating activities: |  |                             |       |   |      |   |       |  
|Depreciation and amortization                                                            |  |                             | 79    |   |      |   | 121   |  
|Stock-based compensation                                                                 |  |                             | 10    |   |      |   | 105   |  
|Reversal of provision for bad debt                                                       |  |                             | (5    | ) |      |   | (3    | )
|Changes in assets and liabilities:                                                       |  |                             |       |   |      |   |       |  
|Accounts receivable                                                                      |  |                             | (52   | ) |      |   | 393   |  
|Prepaid expenses and other current assets                                                |  |                             | 47    |   |      |   | (151  | )
|Accounts payable                                                                         |  |                             | 122   |   |      |   | 46    |  
|Accrued expenses                                                                         |  |                             | (340  | ) |      |   | (94   | )
|Deposits and other assets                                                                |  |                             | 8     |   |      |   |      |  
|Deferred revenue                                                                         |  |                             | (79   | ) |      |   | 163   |  
|Other liabilities                                                                        |  |                             |      |   |      |   | 40    |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Net cash (used in) provided by operating activities                                      |  |                             | (31   | ) |      |   | 147   |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Cash Flows from Investing Activities:                                                    |  |                             |       |   |      |   |       |  
|Purchases of property and equipment                                                      |  |                             | (13   | ) |      |   | (93   | )
|Decrease in other assets                                                                 |  |                             |      |   |      |   | 8     |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Net cash used in investing activities                                                    |  |                             | (13   | ) |      |   | (85   | )
|                                                                                         |  |                             |       |   |      |   |       |  
|Cash Flows From Financing Activities:                                                    |  |                             |       |   |      |   |       |  
|Principal payments on capital lease obligations                                          |  |                             | (24   | ) |      |   | (27   | )
|Proceeds from exercise of stock options                                                  |  |                             |      |   |      |   | 3     |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Net cash used in financing activities                                                    |  |                             | (24   | ) |      |   | (24   | )
|                                                                                         |  |                             |       |   |      |   |       |  
|Effect of Exchange Rate Changes on Cash                                                  |  |                             | 10    |   |      |   | 22    |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Net (Decrease) Increase in Cash and Cash Equivalents                                     |  |                             | (58   | ) |      |   | 60    |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Cash and Cash Equivalents, Beginning of Period                                           |  |                             | 3,236 |   |      |   | 3,176 |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Cash and Cash Equivalents, End of Period                                                 |  | $                           | 3,178 |   |      | $ | 3,236 |  
|                                                                                         |  |                             |       |   |      |   |       |  
|Cash paid for income taxes                                                               |  | $                           | 8     |   |      | $ | 2     |  
|                                                                                         |  |                            
|Cash paid for interest                                                                   |  | $                           | 4     |   |      | $ | 5     |  
|                                                                                         |  |                            
|Acquisition of equipment under capital lease obligations                                 |  | $                           | 23    |   |      | $ | 27    |  

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Operations

We are a provider of rule engine software and services for mission-critical solutions that support and automate
decisions in real time. Our flagship G2©software applies real-time rule technology for
decisions that optimize operations and that detect, diagnose, and resolve costly problems. With applications based on G2, organizations in manufacturing, utilities, communications, transportation, aerospace, finance, and government increase the
agility of their business operations and achieve greater levels of performance.

2. Basis of Presentation

We have prepared the unaudited consolidated financial statements included in this report pursuant to the rules and regulations of the Securities and Exchange Commission
(the SEC) for interim financial reporting. Certain information and footnote disclosures, normally included in financial statements prepared for the full year in accordance with accounting principles generally accepted in the United
States of America, have been condensed or omitted pursuant to such SEC rules and regulations; nevertheless, our management believes that the disclosures in this report are adequate to make the information presented not misleading. In the opinion of
management, the consolidated financial statements reflect all adjustments of a normal and recurring nature that are necessary to present fairly our consolidated financial position as of March 31, 2007 and December 31, 2006 and our results
of operations and cash flows for the three-month periods ended March 31, 2007 and 2006. These consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto
included in our Annual Report on Form 10-K for the year ended December 31, 2006, filed with the SEC on June 6, 2007. The results of operations for interim periods are not necessarily indicative of the results of operations for the full
year or any other interim period.

During the three-month period ended March 31, 2007, we were operating and overall profitable, but did not achieved
positive cash flow. During the year ended December 31, 2006, we incurred operating and net losses, but achieved positive cash flow. We believe that our cash and cash equivalent balance and cash flows from operations will be sufficient to meet
our operating, investing and financing cash flow requirements through at least the next 12 months. Our ability to restore growth and profitability in 2007 and beyond is dependent on market acceptance of our existing and next generation of G2 and
G2-based products and related services and on renewal of maintenance contracts for customer support at near-current levels.

Managements expectations
for future revenue growth, profitability, and operating cash flows involve significant judgments and estimates. Should these judgments and estimates prove to be inaccurate, we have the intent and ability to reduce our costs and delay, scale back, or
eliminate certain of our activities in order to ensure that we maintain positive cash and working capital. Any of these actions could have a material adverse long-term effect on our business, financial condition and results of operations.

3. Restatement of Previously Issued Financial Statements.

On July 19, 2006, we announced that our Audit Committee had commenced a review of the revenue recognition accounting for certain software license and service agreement transactions entered into during fiscal 2004
and 2005. The Audit Committee notified our independent registered public accounting firm and engaged outside legal counsel and outside accounting specialists to assist it with the review.

Based on its preliminary review as of the announcement date, the Audit Committee concluded, in consultation with and upon the recommendation of
management, that previously issued financial statements included in our Annual Reports on Form 10-K for the fiscal years ended December 31, 2004 and 2005 and in our Quarterly Reports on Form 10-Q for the fiscal quarters ended
March 31, June 30 and September 30, 2005 and March 31, 2006, and all of our related earnings releases and similar communications relating to all such fiscal periods, should no longer be relied upon.

In November 2006, we announced that the scope of the Audit Committees investigation had been expanded to include software license and services
agreements entered into from 2000 to 2004. We also reported that the expanded scope included a self-initiated review of historical stock option grant practices and related accounting treatment.

On June 6, 2007, we announced that in connection with our internal review of accounting practices and oversight with respect to the accounting for
certain software license and service agreement transactions and the self-initiated review of our historic stock option granting practices, we restated our financial statements as of and for the years ended December 31, 2005, 2004, 2003, 2002,
2001 and 2000. We also restated the condensed consolidated financial statements for each of the four quarters of 2005 and the first quarter of 2006. In connection with this restatement, on June 6, 2007 we filed with the Securities and Exchange
Commission our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, our Quarterly Reports on Form 10-Q for the second and third fiscal quarters of 2006 ended June 30, 2006 and September 30, 2006, respectively, and
amended our Quarterly Report on Form 10-Q/A for the fiscal quarter ended March 31, 2006.

The restated financial statements for the
first quarter of 2006 and information relating to the restatement are contained in Amendment No. 1 to our Quarterly Report on Form 10-Q/A for the fiscal quarter ended March 31, 2006 that was filed with the Securities and Exchange
Commission on June 6, 2007. All references in this Quarterly Report on Form 10-Q to our financial statements, operations, assets, liabilities and cash flows for the first quarter 2006 are references to such data and information as restated.

4. Comprehensive Loss

The components of comprehensive
income (loss) for the three-month periods ended March 31, 2007 and 2006 are as follows (in thousands)



|                                        |  |                              |     |      |   |      |  
|--------------------------------------- |  | ---------------------------- | --- | ---- | - | ---- | -
|                                        |  | Three Months Ended March 31, |    
|                                        |  | 2007                         |     | 2006 |  
|Net income (loss)                       |  | $                            | 179 |      | $ | (473 | )
|Other comprehensive income (loss):      |  |                              |     |      |   |      |  
|Foreign currency translation adjustment |  |                              | 10  |      |   | 18   |  
|                                        |  |                              |     |      |   |      |  
|Comprehensive income (loss)             |  | $                            | 189 |      | $ | (455 | )
|                                        |  |                              |     |      |   |      |  

5. Net Income (Loss) Per Share

The following is a reconciliation of basic and diluted weighted average shares (in thousands) used in the computation of net income (loss) per share:



|                                             |  |                             |  |      
|-------------------------------------------- |  | --------------------------- |  | -----
|                                             |  | Three Months EndedMarch 31,
|                                             |  | 2007                        |  | 2006 
|Weighted average common shares outstanding   |  | 7,878                       |  | 7,437
|Additional dilutive common stock equivalents |  | 174                         |  |     
|                                             |  |                             |  |      
|Diluted weighted average shares              |  | 8,052                       |  | 7,437
|                                             |  |                             |  |      



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)



For the three-month periods ended March 31, 2007 and 2006, options to purchase 380,193 and 830,072 shares of
common stock, respectively, were outstanding, but not included in the computation of diluted earnings per share. In the 2007 period, 380,193 shares were not included in the computation of diluted earnings per share because the exercise price per
share was greater than the average market price per share. In the 2006 period, 830,072 shares were not included as the shares were anti-dilutive because we had a net loss for the period.

6. Stock Based Compensation

We issue stock options to our employees and outside directors and provide employees the
right to purchase stock pursuant to stockholder approved stock option plans.

Effective January 1, 2006, we adopted Statement of Financial Accounting
Standard (SFAS) No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R). Under the provisions of SFAS No. 123R, we recognize the fair value of stock compensation in net income, over the requisite service period
of the individual grantees, which generally equals the vesting period. All of our stock compensation is accounted for as equity instruments and there have been no liability awards granted.

We have elected the modified prospective transition method for adopting SFAS No. 123R. Under this method, the provisions of SFAS No. 123R apply to all awards
granted or modified after the date of adoption. The unrecognized expense of awards not yet vested at the date of adoption are recognized in net income in the periods after the date of adoption using the same valuation method (i.e.
Black-Scholes) and assumptions determined under the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as disclosed in our previous filings. Under the provisions of SFAS 123R, we recorded $10,000 and $94,000 of
stock-based compensation on our consolidated condensed statements of operations for the three months ended March 31, 2007 and 2006, respectively. The adoption of SFAS No. 123R had no effect on cash flow from operations for the three months
ended March 31, 2007. The stock-based compensation for the three months ended March 31, 2007 and 2006 is included in the following expense categories (in thousands):



|                           |  |                              |    |      |   |   
|-------------------------- |  | ---------------------------- | -- | ---- | - | --
|                           |  | Three Months Ended March 31,
|                           |  | 2007                         |    | 2006
|Cost of service and other  |  | $                            |   |      | $ | 3 
|Selling and marketing      |  |                              | 4  |      |   | 8 
|Research and development   |  |                              |   |      |   | 6 
|General and administrative |  |                              | 6  |      |   | 77
|                           |  |                              |    |      |   |   
|                           |  | $                            | 10 |      | $ | 94
|                           |  |                              |    |      |   |   

During the three months ended March 31, 2006, we issued 6,006 shares of common stock with a fair value of
$10,000 to members of management in lieu of cash payment for a portion of their bonus accrued in 2005. This amount was excluded from the table above. No common shares were issued to management during the three months ended March 31, 2007.

We utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted after the adoption of SFAS No. 123R. No
options were granted during the three month period ended March 31, 2007. The weighted-average fair value of the options granted for the three months ended March 31, 2006 was $1.67 using the following assumptions:



|                                 |  |                             |  |         |  
|-------------------------------- |  | --------------------------- |  | ------- | -
|                                 |  | Three Months EndedMarch 31, | 
|                                 |  | 2007                        |  | 2006    |  
|Average risk free interest rates |  | n/a                         |  | 4.75    | %
|Expected dividend yield          |  | n/a                         |  | None    |  
|Expected life                    |  | n/a                         |  | 7 Years |  
|Expected volatility              |  | n/a                         |  | 130     | %



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GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)



The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention
to pay cash dividends. Expected volatility is based on the historical volatility of our common stock over the period commensurate with or longer than the expected life of the options. The risk-free interest rate is based upon interpolation of
various U.S. Treasury rates on the date of grant. The expected life is based upon historical experience.

Based on the our historical turnover rates, an
annualized estimated forfeiture rate of 10% has been used in calculating the recorded expense. Under the true-up provisions of SFAS No. 123R, additional expense will be recorded if the actual forfeiture rate is lower than estimated, and a
recovery of prior expense will be recorded if the actual forfeiture is higher than estimated. Specific, large forfeitures are identified on an individual basis.

Changes in outstanding stock options for the three months ended March 31, 2007, were as follows:



|                                 |  |                        |   |  |                                 |      |                                                    |      |                                 |   |    
|-------------------------------- |  | ---------------------- | - |  | ------------------------------- | ---- | -------------------------------------------------- | ---- | ------------------------------- | - | ---
|                                 |  | Number of StockOptions |   |  | Weighted- AverageExercise Price |      | Weighted- AverageRemainingContractual Termin Years |      | AggregateIntrinsicValue($000s)
|Outstanding at December 31, 2006 |  | 830,072                |   |  | $                               | 1.54 |                                                    |      |                                 |   |    
|Granted                          |  |                       |   |  |                                 |     |                                                    |      |                                 |   |    
|Exercised                        |  | (332                   | ) |  |                                 | 0.63 |                                                    |      |                                 |   |    
|Forfeited                        |  | (9,150                 | ) |  |                                 | 1.28 |                                                    |      |                                 |   |    
|                                 |  |                        |   |  |                                 |      |                                                    |      |                                 |   |    
|Outstanding at March 31, 2007    |  | 820,590                |   |  | $                               | 1.53 |                                                    | 5.31 |                                 | $ | 179
|                                 |  |                        |   |  |                                 |      |                                                    |      |                                 |   |    
|Exercisable at March 31, 2007    |  | 790,091                |   |  | $                               | 1.54 |                                                    | 5.34 |                                 | $ | 177
|                                 |  |                        |   |  |                                 |      |                                                    |      |                                 |   |    

As of March 31, 2007 and 2006 we had $25,249 and $559,000 of unrecognized compensation cost related to
unvested awards, which we expect to recognize over a weighted-average period of 2 years.

The intrinsic value of options exercised for the three months
ended March 31, 2007 and March 31, 2006 was $300 and $12,000, respectively.

7. Segment Reporting

Revenue is presented geographically based on the country to which the product is shipped or where the services are provided. The following table presents revenues by
geographic area:



|               |  |                             |   |  |      |  
|-------------- |  | --------------------------- | - |  | ---- | -
|               |  | Three Months EndedMarch 31, |  
|               |  | 2007                        |   |  | 2006 |  
|United States  |  | 39                          | % |  | 45   | %
|Rest of Europe |  | 19                          | % |  | 19   | %
|Sweden         |  | 11                          | % |  | 7    | %
|Italy          |  | 10                          | % |  | 7    | %
|Canada         |  | 8                           | % |  | 10   | %
|Rest of World  |  | 7                           | % |  | 6    | %
|Asia           |  | 6                           | % |  | 6    | %
|               |  |                             |   |  |      |  
|               |  | 100                         | % |  | 100  | %
|               |  |                             |   |  |      |  



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)



Revenues from one customer represented 12% and 13% of total revenues for the three months ended March 31, 2007
and the corresponding period in 2006.

The following table presents our long-lived assets, net of depreciation and amortization, as of March 31, 2007
and December 31, 2006 (in thousands):



|              |  |               |     |                  |   |    
|------------- |  | ------------- | --- | ---------------- | - | ---
|              |  | March 31,2007 |     | December 31,2006
|United States |  | $             | 484 |                  | $ | 523
|Europe        |  |               | 35  |                  |   | 38 
|              |  |               |     |                  |   |    
|Total         |  | $             | 519 |                  | $ | 561
|              |  |               |     |                  |   |    



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##### Table of Contents

|ITEM 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements and information
relating to us and our subsidiaries, which are based on managements beliefs, as well as assumptions made by our management and information currently available to us. These statements are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q, words such as anticipate, believe, estimate, expect, intend and similar expressions, as they relate to our
management or us, identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties, and assumptions, including but not limited to those factors set forth in
Item 1A of Part II under the caption Risk Factors. Should one or more of these risks or uncertainties materialize, or should an underlying assumption prove incorrect, actual results may vary materially from those described in this
report as anticipated, believed, estimated, expected or intended. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We undertake no obligation to update or revise
any forward-looking statements.

Business Overview

We
are a provider of rule engine software and services for mission-critical solutions that support and automate decisions in real time. Our flagship G2 software applies real-time rule technology to information in order to optimize operations and
detect, diagnose and resolve costly problems. With applications based on G2, organizations in manufacturing, utilities, communications, transportation, aerospace, finance and government increase the agility of their business operations and achieve
greater levels of performance.

Our products apply rule-logic in real time to enable organizations to make better operational decisions. Benefits derived
from the use of our products include:



| |  |  | greater agility in responding to changing business conditions;
| | - |  | --------------------------------------------------------------



| |  |  | increased production capacities;
| | - |  | --------------------------------



| |  |  | reduced consumption of energy, materials and resources;
| | - |  | -------------------------------------------------------



| |  |  | avoidance of capital expenditures;
| | - |  | ----------------------------------



| |  |  | waste reduction;
| | - |  | ----------------



| |  |  | higher levels of product and service quality; and
| | - |  | -------------------------------------------------



| |  |  | avoidance of costly operational disruptions and shutdowns.
| | - |  | ----------------------------------------------------------

Our key product is G2, a mature and robust software platform that underlies all of our other products. In June 2007, we released G2 version 8.3, which supports web-based standards, SOAP and Web Services, new Business Rules analysis
techniques, extensions to its BPEL implementation as well as additional flexibility in building rich client, Windows based user interfaces.

We offer a
number of products that use G2 as a platform. These products enable customers to implement certain types of applications more quickly and economically by providing domain-specific functionality.

Our current products are:



|                |  |                                                                                                                             
|--------------- |  | ----------------------------------------------------------------------------------------------------------------------------
|Product         |  | Application                                                                                                                 
|G2©             |  | Real-time, rule engine platform for optimizing operations and detecting, diagnosing and responding to problems in real time.
|                | 
|G2 NeurOn-Line |  | Online, rule-driven neural-network models that predict, control and optimize complex non-linear processes.                  
|                | 
|G2 Optegrity©   |  | Abnormal condition management for process manufacturing plants.                                                             
|                | 
|G2 Integrity   |  | Expert fault management of voice and data networks.                                                                         
|                | 
|G2 ReThink®     |  | Management of the business process life cycle through rule-driven simulation and online automation.                         
|                | 
|G2 e-SCOR       |  | Simulation and analysis of supply-chain designs, policies and practices.                                                    



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##### Table of Contents

We have a professional services group that can be engaged by our customers to develop applications or to assist in the
development of applications. However, many of our customers, particularly our partners, build their own applications. We also offer courses to train customers in the use of our products.

We derive revenue from sales of and service for our products and account for such revenue in four ways:



| |  |  | Sale of product licensesmostly one-time payment for perpetual licenses.
| | - |  | ------------------------------------------------------------------------



| |  |  | Customer support servicesincludes both product support and product enhancements and updates. Pricing is generally based on a percentage of the price of
the product license. Service contracts, mandatory for the first year following the purchase of a product license, are typically for one-year periods. Payment is due at the commencement of each support year, but revenue is recognized over the course
of the year.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Consulting servicesvarious billable services to customers for helping develop and install applications. Most of these services are billed on a time and
materials basis. Occasionally, we enter into fixed price arrangements, which are usually accounted for using a proportional performance model.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Educational servicestraining in the use of our products, some in public classes and some in-house for customers who require a dedicated training
program. These services are billed on a course-fee or day-rate basis.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We have a sales force in the United States and Europe. Our sales
force is focused on the generation of new business in several vertical and horizontal markets. The vertical markets include: government, process manufacturing, discrete manufacturing, power utilities, water utilities, telecommunications, government,
transportation, and aerospace. The horizontal markets include business process management, supply chain management, and modeling and simulation.

Our sales
activities have historically involved a combination of direct sales to end users and indirect sales through partners. We have an indirect channel strategy for our sales force that places its primary focus on development of new business through
indirect channels. In addition, our sales force supports the current and future needs of our existing end user customers. As part of the execution of our indirect channel strategy we use indirect channel programs designed to attract new partners and
to support existing partners, who pursue business based on our products across our target vertical markets. Channel partners are also able to provide development, support and training services to our customers. We have channel partners in North and
South America, Europe, the Middle East, Africa and the Asian-Pacific region.

The following is the breakdown of revenue by product and service revenue:



|                                    |  |                             |   |  |      |  
|----------------------------------- |  | --------------------------- | - |  | ---- | -
|                                    |  | Three Months EndedMarch 31, |  
|                                    |  | 2007                        |   |  | 2006 |  
|Product license sales               |  | 39                          | % |  | 43   | %
|Consulting and educational services |  | 20                          | % |  | 17   | %
|Customer support services           |  | 41                          | % |  | 40   | %
|                                    |  |                             |   |  |      |  
|Total                               |  | 100                         | % |  | 100  | %
|                                    |  |                             |   |  |      |  

Prices for our products are generally denominated in U.S. dollars or Euros. Telecommunications, the U.S.
government, particularly the Department of Defense, manufacturing, and transportation are major markets for us. We have several significant OEM partners, including Siemens, Ericsson, and Motorola.

Critical Accounting Policies

The discussion and analysis of our
financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to bad debts, income taxes, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For a more detailed explanation of the judgments made in these areas, refer to our Annual Report on Form 10-K for the year ended December 31, 2006.



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##### Table of Contents

Results of Operations

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



|                                                |  |                             |   |  |      |   
|----------------------------------------------- |  | --------------------------- | - |  | ---- | --
|                                                |  | Three Months EndedMarch 31, |  
|                                                |  | 2007                        |   |  | 2006 |   
|Product                                         |  | 39                          | % |  | 44   | % 
|Services                                        |  | 61                          | % |  | 56   | % 
|                                                |  |                             |   |  |      |   
|Total revenues                                  |  | 100                         | % |  | 100  | % 
|                                                |  |                             |   |  |      |   
|Cost of revenues:                               |  |                             |   |  |      |   
|Product                                         |  | 3                           | % |  | 3    | % 
|Services                                        |  | 27                          | % |  | 22   | % 
|                                                |  |                             |   |  |      |   
|Total cost of revenues                          |  | 30                          | % |  | 25   | % 
|                                                |  |                             |   |  |      |   
|Gross profit                                    |  | 70                          | % |  | 75   | % 
|                                                |  |                             |   |  |      |   
|Operating expenses                              |  |                             |   |  |      |   
|Sales and marketing                             |  | 17                          | % |  | 34   | % 
|Research and development                        |  | 17                          | % |  | 25   | % 
|General and administrative                      |  | 30                          | % |  | 28   | % 
|                                                |  |                             |   |  |      |   
|Total operating expenses                        |  | 64                          | % |  | 87   | % 
|                                                |  |                             |   |  |      |   
|Operating income (loss)                         |  | 6                           | % |  | (12  | )%
|Other expense, net                              |  | 0                           | % |  | 0    | % 
|                                                |  |                             |   |  |      |   
|Income (loss) before provision for income taxes |  | 6                           | % |  | (12  | )%
|Provision for income taxes                      |  | 2                           | % |  | 0    | % 
|                                                |  |                             |   |  |      |   
|Net income (loss)                               |  | 4                           | % |  | (12  | )%
|                                                |  |                             |   |  |      |   

Revenues

We derive revenue from two sources: product and services. Product revenues include revenues from sales of licenses for use of our software products which include G2 and related application software. Services revenues
consist of fees for support and maintenance, which is generally provided on an annual contract basis; consulting services; and training courses related to our products.

We derive revenues from both U.S. and international customers. Revenues for the three-month periods ended March 31, 2007 and 2006 were as follows:



|              |  |                                            |       |  |      |   |  |   |       |  |    |  
|------------- |  | ------------------------------------------ | ----- |  | ---- | - |  | - | ----- |  | -- | -
|              |  | Three Months Ended March 31,(in thousands) |      
|              |  | 2007                                       |       |  | 2006 |  
|U.S.          |  | $                                          | 1,601 |  | 39   | % |  | $ | 1,733 |  | 45 | %
|International |  |                                            | 2,492 |  | 55   | % |  |   | 2,155 |  | 55 | %
|              |  |                                            |       |  |      |   |  |   |       |  |    |  
|              |  | $                                          | 4,093 |  |      |   |  | $ | 3,888 |  |    |  
|              |  |                                            |       |  |      |   |  |   |       |  |    |  

The overall increase in revenue of $0.2 million or 5% between the three-months ended March 31, 2007 and the
same period in 2006 was primarily the result of an increase in consulting projects.

The overall decrease in U.S. revenues was the result of a decrease in
license revenues for the three-months ended March 31, 2007 as compared to the same period in 2006, partially offset by an increase in revenue from service contracts and an increase in consulting projects. The increase in international revenues
for the three-month period ended March 31, 2007 was primarily a result of a $0.1 million increase in consulting projects and an increase in partner license revenue.

Our worldwide product and service revenues for the three-month periods ended March 31, 2007 and 2006 were as follows:



|        |  |                                            |       |  |      |   |  |   |       |  |    |  
|------- |  | ------------------------------------------ | ----- |  | ---- | - |  | - | ----- |  | -- | -
|        |  | Three Months Ended March 31,(in thousands) |      
|        |  | 2007                                       |       |  | 2006 |  
|Product |  | $                                          | 1,605 |  | 39   | % |  | $ | 1,692 |  | 44 | %
|Service |  |                                            | 2,488 |  | 61   | % |  |   | 2,196 |  | 56 | %
|        |  |                                            |       |  |      |   |  |   |       |  |    |  
|Total   |  | $                                          | 4,093 |  |      |   |  | $ | 3,888 |  |    |  
|        |  |                                            |       |  |      |   |  |   |       |  |    |  



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##### Table of Contents

Product revenues for the three months ended March 31, 2007 decreased by $0.1 million, or 5%, as compared to the same
period in 2006 due to a reduction in license bookings.

Services revenues for the three months ended March 31, 2007 increased $0.3 million, or 13%, as
compared to the same period in 2006. This increase was mainly attributable to an increase in government consulting and training orders during the quarter and a slight increase in license maintenance revenue from orders placed in prior periods.

One customer accounted for 12% of revenues for the three-month period ended March 31, 2007 and 13% of revenue for the three-month period ended
March 31, 2006.

Cost of Revenues

Cost of revenues primarily consist of consulting labor, technical support costs, and the costs of material and labor involved in producing and distributing our software. These costs for the three-month periods ended March 31, 2007 and
2006 were as follows:



|        |  |                                             |       |      |   |    
|------- |  | ------------------------------------------- | ----- | ---- | - | ---
|        |  | Three Months Ended March 31, (in thousands)
|        |  | 2007                                        |       | 2006
|Product |  | $                                           | 117   |      | $ | 131
|Service |  |                                             | 1,125 |      |   | 858
|        |  |                                             |       |      |   |    
|Total   |  | $                                           | 1,242 |      | $ | 989
|        |  |                                             |       |      |   |    

Product costs remained consistent for the three months ended March 31, 2007 as compared to the same period in
2006.

Service costs increased $0.3 million, or 31%, for the three months ended March 31, 2007 as compared to the same period in 2006. This increase
was primarily attributable to $0.2 million of costs associated with a long term contract that was deferred in the first quarter of 2006 and no similar deferral was required in 2007 and, $0.1 million of costs associated with contractors used to
support the increased consulting revenue, partially offset by $0.05 decrease in salary due to a reduction in personnel as a result of our restructuring in August 2006.

Gross margin percentages for the three-month periods ended March 31, 2007 and 2006 were as follows:



|        |  |                              |   |  |      |  
|------- |  | ---------------------------- | - |  | ---- | -
|        |  | Three Months Ended March 31, |  
|        |  | 2007                         |   |  | 2006 |  
|Product |  | 93                           | % |  | 92   | %
|Service |  | 55                           | % |  | 61   | %
|        |  |                              |   |  |      |  
|Total   |  | 70                           | % |  | 75   | %

Our gross margin on product remained relatively consistent the same, at 93% and 92%, during the three-month period
ended March 31, 2007 as compared to the same period in 2006. Our product expenses are relatively low and consistent as they generally consist of fixed labor and facility costs, therefore, the gross margin remains consistent unless there is a
significant change in license revenue.

Our gross margin on service decreased 6% from 61% to 55% for the three-month period ended March 31, 2007 as
compared to the same period in 2006. Our service expenses increased as a percentage of our revenue based on the increased costs identified above.



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##### Table of Contents

Operating Expenses



|                           |  |                             |       |      |   |      
|-------------------------- |  | --------------------------- | ----- | ---- | - | -----
|                           |  | Three Months EndedMarch 31,
|                           |  | 2007                        |       | 2006
|Operating expense:         |  |                             |       |      |   |      
|Sales and marketing        |  | $                           | 710   |      | $ | 1,304
|Research and development   |  |                             | 672   |      |   | 961  
|General and administrative |  |                             | 1,224 |      |   | 1,097
|                           |  |                             |       |      |   |      
|Total operating expense    |  | $                           | 2,606 |      | $ | 3,362

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 for the three-month period ended March 31, 2007 were $0.7
million, a decrease of $0.6 million, or 46%, as compared to the same period in 2006. The decrease was primarily attributable to a $0.3 million decrease in personnel expense as there were seven less people as a result of our restructuring plan
executed in August 2006, a $0.1 million decrease in outside professional marketing personnel and contractors based on their elimination in our cost reduction programs, a $0.1 million decrease in general marketing programs, a $0.1 million decrease in
commissions, a $0.04 million decrease in travel based on the reduction in personnel, and a $0.03 million decrease in our allocation from consulting support of sales.

Research and Development. Research and development expenses consist primarily of costs of personnel, equipment and facilities. Total research and development expenses for the three months ended March 31,
2007 was $0.7 million, down $0.3 million or 30% as compared to the same period in 2006. This was primarily the result of a decrease of $0.2 million in personnel expense as there were six less personnel as a result of our restructuring plan executed
in August 2006 and, a decrease of $0.1 million of contractors and outside services that were discontinued.

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 for the three months ended March 31, 2007 were $1.2 million,
an increase of $0.1 million or 12% as compared to the same period in 2006. This increase was the result of $0.3 million for contractors in support of the restatement process, $0.1 million in additional legal fees in support of the restatement
process, $0.1 million in additional accounting fees in support of the restatement process, partially offset by a $0.3 million decrease in personnel expense, and a $0.1 million decrease in stock based compensation.

Other Income, Expenses

Other expenses, net for the
three months ended March 31, 2007 were $11,000, compared to other expenses, net of $8,000 for the same period in 2006. The decrease is primarily due to foreign exchange rate fluctuations.

Income Taxes

Our provision for income taxes results
from anticipated income tax credits in the U.S. based on operating loss carry forwards offset by tax liabilities in foreign jurisdictions where our wholly owned subsidiaries have taxable income but may not have operating loss carry forwards to
reduce tax obligations. Provision for income taxes for the three months ended March 31, 2007 was $55,000, compared to $2,000 for the same period in 2006.

Liquidity and Capital Resources

Our March 31, 2007 cash and cash equivalents remained the same at $3.2 million, as compared to
December 31, 2006.

For the quarter ended March 31, 2007, we had $0.03 million used in operating activities, $0.01 million used in investing
activities and $0.02 million used in financing activities.

Cash flows used in operations were $0.03 million for the three-month periods ended
March 31, 2007 as compared to $0.1 million provided by operations in the same period in 2006.

Cash flows used in investing activities were relatively
consistent at $0.01 million and $0.09 million for the three-month periods ended March 31, 2007 and 2006, respectively, and were primarily used for purchases of property and equipment.

Cash flows used in financing activities were $0.02 million for the three-month period ended March 31, 2007 and 2006, and were primarily used for principal payments
on capital lease obligations.



14



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##### Table of Contents

We currently finance our operations, along with capital expenditures, primarily through cash flows from operations and
our current cash. Our lease commitments consist of operating leases primarily for our facilities and computer equipment. We also have capital leases for certain computer equipment.

Managements expectations for future revenue growth, profitability, and operating cash flows involve significant judgments and estimates. Should these judgments and estimates prove to be inaccurate, we have the
intent and ability to reduce our costs and delay, scale back, or eliminate certain of our activities in order to ensure that we maintain positive cash and working capital. Any of these actions could have a material adverse long-term effect on our
business, financial condition and results of operations.

Commitments and Contingencies

Leases

We lease our facilities and certain equipment
under operating and capital leases. The future minimum annual payments under these leases at March 31, 2007 are as follows:



|                                              |  |                 |       |               |   |    
|--------------------------------------------- |  | --------------- | ----- | ------------- | - | ---
|                                              |  | (in thousands) 
|For the period ended December 31,             |  | OperatingLeases |       | CapitalLeases
|2007                                          |  | $               | 426   |               |   | 97 
|2008                                          |  |                 | 442   |               |   | 44 
|2009                                          |  |                 | 406   |               |   | 28 
|2010                                          |  |                 | 400   |               |   | 2  
|2011                                          |  |                 | 112   |               |   |   
|Thereafter                                    |  |                 |      |               |   |   
|                                              |  |                 |       |               |   |    
|Total minimum lease payments                  |  | $               | 1,786 |               | $ | 171
|Less: Amount representing interest and fees   |  |                 |       |               |   | 17 
|                                              |  |                 |       |               |   |    
|Present value of minimum lease payments       |  |                 |       |               |   | 154
|Less: Current portion                         |  |                 |       |               |   | 108
|                                              |  |                 |       |               |   |    
|Long-term portion of capital lease obligation |  |                 |       |               | $ | 46 

Litigation

We are involved in various lawsuits, claims and inquiries, most of which are routine to the nature of our business. In the opinion of our management, the resolution of these matters will not have a material adverse
effect on our financial position, results of operations or cash flows.

Stock Repurchase Program

In the third quarter of 1998, we began a program to repurchase up to 650,000 shares of our common stock on the open market. As of March 31, 2007, 501,300 shares had
been repurchased at a cost of approximately $1,869,000. No shares were purchased in 2007, 2006 or 2005. During the three months ended March 31, 2007 and 2006, respectively, we reissued no shares and 11,312 shares of common stock to employees
and non-employee directors. As of March 31, 2007, 332,369 shares remained in treasury at a cost of $1,239,736.

Related party transaction

On January 9, 2002 we entered into a three-year Original Equipment Manufacturer agreement with Integration Objects Inc., an offshore Tunisian
corporation involving three employees who continue to work for us. In March 2005, July 2005, June 2006 and April 2007 we extended the agreement for additional increments. The contract expired on February 13, 2007. On February 15,
2007 we signed a new one-year Original Equipment Manufacturer agreement which will expire on February 14, 2008. Both agreements call for the payment of royalties, based on a fixed and determinable percentage of the product sales price, in
connection with our use of their product. These payments are to be made within 30-days after payment from the end user is received. In April 2007, we terminated one of the employees involved with Integration Objects and determined that the other two
employees were no longer associated with Integration Objects. We paid $56,931 to Integration Objects, Inc. during the three-months ended March 31, 2007. At March 31, 2007 we had unpaid royalties of $49,554 due to Integration Objects, Inc.



15



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##### Table of Contents

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No.48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No.109(FIN 48). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an entitys financial statements in accordance with Statement 109 and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN48 did not have a material
impact to our consolidated financial statements.



|ITEM 3. | Quantitative and Qualitative Disclosures About Market Risk Investment Portfolio
|------- | -------------------------------------------------------------------------------

We do not use derivative financial instruments in our investment portfolio. If we place our funds in other than demand deposit accounts, we use instruments that meet high credit quality standards, such as money market
funds, government securities, and commercial paper. We limit the amount of credit exposure to any one issuer. At March 31, 2007, substantially all of our funds were in demand deposit accounts.

Impact of Foreign Currency Rate Changes

Our contracts with customers
are generally denominated in U.S. dollars or Euros. We transact business in various countries and thus have exposure to adverse movements in foreign currency exchange rates. This exposure is primarily related to intercompany receivable and payable
balances that are recorded on the balance sheet in currencies other than the functional currency. These amounts are translated at each month end to the functional currency in each country, and any resulting gain or loss is recorded in the currency
translation adjustment of the equity section of the balance sheet. In addition, we have certain cash balances held in currencies other than our functional currency or the functional currency of our subsidiaries. These amounts are translated at each
month end to the functional currency in each country, and any resulting gain or loss is recorded in the appropriate statements of operations.



|ITEM 4. | Controls and Procedures.
|------- | ------------------------

Our management, with the participation of
our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2007. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies
its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2007, as a result of the material weaknesses in our internal
controls over financial reporting described below, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were not effective.

In July 2006, we announced that our Audit Committee had undertaken a detailed investigation of the revenue recognition accounting for software license and service
agreement transactions entered into during fiscal 2004 and 2005. In November 2006, we expanded the investigation to include software license and services agreements entered into from 2000 to 2004. We also began a self-initiated review of historical
stock option grant practices and related accounting treatment. The investigation and review were conducted with the assistance of outside legal counsel and outside accounting specialists. Based on the investigation and review, management and the
Audit Committee concluded that errors in revenue recognition, which primarily result in the deferral of revenue into later periods than originally recognized, stock compensation and other accounting adjustments required us to restate previously
reported financial results. The restatement affected previously reported results from 2000 through the first quarter of 2006.

In connection with the
restatement, we assessed the effectiveness of our internal control over financial reporting. We and our independent registered public accounting firm, Vitale, Caturano & Company, Ltd., identified and reported to our Audit Committee material
weaknesses in our internal control over financial reporting identified in connection with the audit of our financial statements



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for the year ended December 31, 2006. These material weaknesses include entity-level control weaknesses as well as weaknesses in process and transaction
controls as defined in the Committee of Sponsoring Organizations of the Treadway Commission (COSO) criteria.

The following material weaknesses
collectively resulted in us prematurely recognizing revenue, thereby causing revenue to be overstated in an earlier period and understated in a later period, deferred revenue to be understated in any period, costs and expenses to vary in any
particular period and our net loss to be understated in an earlier period and overstated in a later period. As a consequence, we restated our historical financial statements as of and for the years ended December 31, 2005, 2004, 2003, 2002,
2001 and 2000 and for each of the four quarter in 2005 and the first quarter of 2006.

We identified the following material weaknesses in connection with
the audit of our financial statements for the year ended December 31, 2006:



| |  |  | inappropriate level of responsibility for contract review and approval, as well as revenue recognition decisions;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | insufficient flow of documentation and information between operations and finance personnel;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | inappropriate responsibility of vice president of operations in overseeing the performance of the sales force and approving contracts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | insufficient review of contracts by the operations personnel to ensure proper data entry of standard and non-standard terms;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | insufficient tracking of the issuance and return of license key codes;
| | - |  | ----------------------------------------------------------------------



| |  |  | insufficient tracking of inventory maintained by resellers; and
| | - |  | ---------------------------------------------------------------



| |  |  | insufficient processes for approving, issuing, documenting and accounting for stock option grants.
| | - |  | --------------------------------------------------------------------------------------------------

Beginning in the quarter ended June 30, 2006, we took a number of corrective actions to address the material weaknesses discussed above, including:



| |  |  | implementing enhanced accounting policies and internal controls, as well as improved sales policies and procedures, relating to sales, license delivery, consulting
management and product exchanges and returns;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | developing and implementing internal controls and compliance training programs for sales, operations and finance;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | implementing personnel changes;
| | - |  | -------------------------------



| |  |  | establishing clear and concise corporate polices, practices and controls; and
| | - |  | -----------------------------------------------------------------------------



| |  |  | implementing formal and documented procedures for approving, issuing, documenting and accounting for stock option grants.
| | - |  | -------------------------------------------------------------------------------------------------------------------------

In addition, we implemented changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. These changes include:



| |  |  | implementation of a multi-person review process of revenue packages, including system generated reports, expanded documentation requirements and approval
requirements of the chief financial officer; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | formalization of ongoing reporting of contract statuses and related issues to senior management, including the chief financial officer.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------

We note, however, that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues including instances of fraud, if any, have been detected.
These inherent limitations include the realities that judgments in decision-making can be faulty, and breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions. Over time, our control systems may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because
of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected and could be material and require a restatement of our financial statements.



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PART II. OTHER INFORMATION



|ITEM 1. | Legal Proceedings
|------- | -----------------

We are involved in various lawsuits, claims and
inquiries, most of which are routine to the nature of our business. In the opinion of management, the resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flow.



|ITEM 1A. | Risk Factors
|-------- | ------------

The following important factors, among others, could
cause our actual operating results to differ materially from those indicated or suggested by forward-looking statements made in this Form 10-Q or presented elsewhere by management from time to time.

The restatement of our consolidated financial statements and the matters relating to the investigations by the Audit Committee and by the Special Committee of the
Board of Directors may result in additional litigation and governmental enforcement actions.

On July 19, 2006, we announced that our Audit
Committee had undertaken a detailed review of the revenue recognition accounting for software license and service agreement transactions entered into during fiscal 2004 and 2005. The Audit Committee notified our independent public accounting firm
and engaged its own legal advisors and forensic accountants to assist it with its investigation. Also in July 2006, our Audit Committee concluded, in consultant and upon the recommendation of management in consultation with and upon the
recommendation of management, that our previously issued financial statements included in our Annual Reports on Form 10-K for the fiscal years ended December 31, 2004 and 2005 and in our Quarterly Reports on Form 10-Q for the interim fiscal
periods ended March 31, June 30 and September 30, 2005 and March 31, 2006, and all of our earnings releases and similar communications relating to those fiscal periods, should no longer be relied upon.

We conducted a review and investigation of several accounting issues with the assistance of outside legal counsel and outside accounting specialists. The review and
investigation included a review of our revenue recognition accounting for certain software license and service agreement transactions, stock option practices and related stock-based compensation expense and other accounting adjustments, including
foreign tax filing errors and accounting timing adjustments. These review and investigations, and related activities, have required us to incur substantial expenses for legal, accounting, tax and other professional services, and have diverted
managements attention from our business.

As a result of the review and investigation of our accounting practices, we recently restated previously
released financial statements for 2000 through the first quarter of 2006. We also recorded cumulative effect adjustments for fiscal years 2000 through 2003, the effects of which are indicated as adjustments to our financial statements as of
December 31, 2003.

While we believe we have made appropriate judgments in our reviews and resulting restatement, the SEC may disagree with the manner
in which we have accounted for and reported the financial impact. Accordingly, there is a risk we may have to further restate our prior financial statements, amend prior filings with the SEC, or take other actions not currently contemplated.

We may also become the subject of, or otherwise required to incur legal fees and costs in connection with, private litigation, regulatory proceedings, or
government enforcement actions. No assurance can be given regarding the outcomes from such activities. The resolution of these matters will be time consuming, expensive, and will distract management from the conduct of our business. Our available
directors and officers liability insurance may not be sufficient to cover our legal expenses or those of persons we are obligated to indemnify. If we are subject to adverse findings in litigation, regulatory proceedings or government
enforcement actions, we could be required to pay damages or penalties or have other remedies imposed, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. Furthermore, the
restatements of our financial results and any resulting litigation or SEC investigation could impact our relationships with customers and our ability to generate revenue.



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We have identified material weaknesses in our disclosure controls and procedures and our internal control over
financial reporting as of March 31, 2007 that, if not remedied effectively, could result in material misstatements in our financial statements in future periods.

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934,
as amended. Our management assessed the effectiveness of our internal control over financial reporting as of March 31, 2007, and identified material weaknesses. Our management also evaluated the effectiveness of our disclosure controls and
procedures and, due to these material weaknesses, our disclosure controls and procedures were not effective as of March 31, 2007.

A material weakness
is defined as a control deficiency, or combination of significant control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A
control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

We identified the following material weaknesses as of December 31, 2006:



| |  |  | inappropriate level of responsibility for contract review and approval, as well as revenue recognition decisions;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | insufficient flow of documentation and information between operations and finance personnel;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | inappropriate responsibility of vice president of operations in overseeing the performance of the sales force and approving contracts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | insufficient review of contracts by the operations personnel to ensure proper data entry of standard and non-standard terms;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | insufficient tracking of the issuance and return of license key codes;
| | - |  | ----------------------------------------------------------------------



| |  |  | insufficient tracking of inventory maintained by resellers; and
| | - |  | ---------------------------------------------------------------



| |  |  | insufficient processes for approving, issuing, documenting and accounting for stock option grants.
| | - |  | --------------------------------------------------------------------------------------------------

For further information about these material weaknesses, please see Item 4  Controls and Procedures included elsewhere in this Quarterly Report on
Form 10-Q. Because of these material weaknesses, management concluded that, as of March 31, 2007, our internal control over financial reporting was not effective.

We have implemented and continue to implement a number of remedial measures designed to address the material weaknesses identified as of December 31, 2006. If these remedial initiatives are insufficient to address the
identified material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control are discovered in the future, we may fail to meet our future reporting obligations on a timely basis, our financial statements
may contain material misstatements, our operating results may be harmed, we may fail to meet our future reporting obligations on a timely basis, we may be subject to litigation. Any failure to address the identified material weaknesses or any
additional material weaknesses or significant deficiencies in our internal control could also adversely affect the results of future management evaluations regarding the effectiveness of our internal control over financial reporting that
are required under Section 404 of the Sarbanes-Oxley Act of 2002. Internal control deficiencies could also cause investors to lose confidence in our reported financial information.

We can give no assurance that the measures we have taken to date or any future measures we may take will remediate the material weaknesses identified or that any additional material weaknesses will not arise in the
future due to a failure to implement and maintain adequate internal control over financial reporting or circumvention of these controls. In addition, even if we are successful in strengthening our controls and procedures, those controls and
procedures may not be adequate to prevent or identify irregularities or facilitate the fair presentation of our financial statements or our periodic reports filed with the SEC.

Failure or circumvention of our internal controls and procedures could seriously harm our business.

Our internal
controls and procedures have been circumvented in the past and may be circumvented in the future. We are making significant changes in our internal control over financial reporting and our disclosure controls and procedures. Any system of controls,
however well designed and operated, is based in part on certain assumptions and can provide only reasonable, and not absolute, assurances that the objectives of the system are met. The failure or circumvention of our controls, policies and
procedures could have a material adverse effect on our business, results of operations and financial condition.



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Our financial statements have been impacted, and could be impacted again, by revenue recognition errors.

We recently restated previously released financial statements for 2000 through the first quarter of 2006, which was in part due to revenue recognition
errors in the accounting for certain software license and service agreements. Our financial statements could be adversely impacted by improper or erroneous application of revenue recognition policies and accounting rules. For instance, revenue
recognition depends on, among other criteria, when: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred (generally FOB shipping point or electronic distribution); (3) the fee is deemed fixed or determinable;
and (4) collection is probable. Our personnel may misrepresent an contract and consent to undocumented terms with a customer, imply delivery that has not occurred, make promises of future concessions or misrepresent a customers credit
rating. We have implemented policies and procedures we hope will prevent and discourage such improper application of revenue recognition policies and accounting rules, but there can be no assurance that such policies will be followed. In addition,
depending on when we learn of improper application of revenue recognition policies, we may have to restate our financial statements for a previously reported period, which would seriously harm our business, operating results and financial condition.

We have a history of operating losses, and we may not be profitable.

We were profitable in the first quarter of 2007 but recognized losses for three of the five years ended December 31, 2006. As of March 31, 2007, our accumulated deficit was $21.9 million. Our ability to
achieve and maintain profitability is dependent on continued revenues from new and existing customers and expense control. There can be no assurance that we will return to profitability and even if we achieve profitability, we cannot assure that we
can sustain profitability on a quarterly or annual basis.

If we are not current in our filings with the SEC, we will face several adverse consequences.

If we are unable to remain current in our financial filings, we will not be able to have a registration statement under the Securities Act of 1933,
covering a public offering of securities, declared effective by the SEC, and we will not be able to make offerings pursuant to existing registration statements or pursuant to certain private placement rules of the SEC under Regulation D,
to any purchasers not qualifying as accredited investors. These restrictions may impair our ability to raise funds in the public markets, should we desire to do so, and to attract and retain key employees.

We are reliant on fees from maintenance contracts and renewals. If we fail to retain our maintenance customers, our revenues may be adversely affected

We rely on maintenance contracts for a significant percentage of our revenues, as software maintenance fees have represented 40%, 41% and 41% of our total revenues in
the years ended December 31, 2006, 2005 and 2004, respectively. Software maintenance fees represented 41% of the total revenues for the three months ended March 31, 2007. While a maintenance contract on our products is mandatory for the
first year after purchase, subsequent renewals of the maintenance contract are at the discretion of our customers. Accordingly, our failure to retain maintenance customers or a significant decline in the rate of maintenance contract renewals could
have a material adverse effect on our business, results of operations, cash flows, and financial position.

We rely heavily on indirect distribution
channels and strategic partner relationships for the sales of our products. If these relationships are disrupted, our revenues may be adversely affected.

We sell our products in part through value-added resellers, systems integrators, original equipment manufacturers and distributors, which are not under our control. Sales of our products by such channel partners represented 67%, 60% and 49%
of our product revenues in years ended December 31, 2006, 2005 and 2004, respectively. Sales of our products by channel partners represented 67% of our total sales for the three months ended March 31, 2007. We rely heavily on our indirect
sales partners for sales of our expert operations management products to new customers. The loss of major original equipment manufacturers or resellers of our products, a significant decline in their sales, or difficulty on the part of such
third-party developers or resellers in developing successful G2-based applications could have a material adverse effect on our business, results of operations, cash flows and financial position. There can be no assurance that we 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 our products. In addition, we rely on third-party resellers to provide post-sales service and support to our
customers, and any deficiencies in such service and support could adversely affect our business, results of operations, cash flows, and financial position.

We depend heavily on our sales and marketing force.

Our future success in the expert operations management marketplace will depend, in
part, upon the productivity of our sales and marketing personnel, our ability to continue to attract, integrate, train, motivate and retain new sales and marketing personnel, and our



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ability to manage sales and channel partners. There can be no assurance that our investment in sales and marketing will ultimately prove to be successful. In
addition, there can be no assurance that our sales and marketing personnel will be able to compete successfully against the significantly more extensive and better funded sales and marketing operations of many of our current and potential
competitors. Our inability to manage our sales and marketing personnel effectively could have a material adverse effect on our business, results of operations, cash flows, or financial position.

Our quarterly operating results may vary, leading to fluctuations in trading prices for our common stock and possible liquidity problems.

We have experienced, and may experience in the future, significant quarter-to-quarter fluctuations in our operating results. There can be no assurance that revenue growth
or profitable operations can be attained on a quarterly or annual basis in the future. Our sales cycle typically ranges from 6 to 12 months, and the cost of acquiring our software, building and deploying applications, and training users represents a
significant expenditure for customers. Our 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, we ship software products within a short
period after receipt of an order and typically do 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 executed in the final weeks of that quarter. The revenues for a quarter may include some large orders. If the timing of
any of these large orders is delayed, it could result in a substantial reduction in revenues for that quarter. Our 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 our results of operations and cash flows, which may impact our ability to continue as an independent concern.

Our
business may suffer if we fail to remain competitive with other companies offering similar products and services.

A number of companies offer products
that offer rule engine capabilities or that perform certain functions of G2 for specific applications. In all of our markets, there is competition from point solutions, real-time and rule engine products, and internally developed
software. There are commercially available software development tools that software application developers or potential customers could use to build software that has functionality similar to our products.

In addition, we believe that end users in our markets are increasingly seeking application-specific products and components as well as complete solutions, rather than
general software tools to develop application-specific functionality and solutions. Meeting this demand has required us to modify our sales approach. We are increasingly reliant on indirect channel partners, including original equipment
manufacturers, value-added resellers, and systems integrators, to satisfy market requirements. A number of software companies offer products that compete in specific application areas addressed by these partners, such as cement kiln control,
manufacturing execution systems, logistics systems, and network management, and they could be successful in supplying alternatives to products based on our software.

Companies offering competitive rule engine products include Fair Isaac, ILOG, and Computer Associates. Certain companies, such as Micromuse and Aspen Technology, sell point solutions that compete with
operations management applications based on G2 with respect to specific applications or uses. Several companies, including ILOG, Pavilion, and System Management Arts, offer operations management products with limited real-time, expert system, or
fault isolation capabilities, but at lower price points than those provided by us. Certain competitors in this category have greater financial and other resources than we do and might introduce new or improved products to compete with G2, possibly
at lower prices.

Many of our 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 our products. There is no assurance that we can
successfully persuade development personnel within these customers organizations to use G2-based products that can cost-effectively compete with their internally developed products. Thus there could be a reduction in the need for our products
and services that may limit our future opportunities.

We believe that continued investment in research and development and sales and marketing will be
required to maintain our competitive position. There can be no assurance that competitors will not develop products or provide services that are superior to our products or services or achieve greater market acceptance. Competitive pressures faced
by us could force us to reduce our prices, which could result in reduced profitability. There can be no assurance that we 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 our business, results of operations, cash flows, or financial position.



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Our business may suffer if we fail to address the challenges associated with international operations.

Our international revenues represented 49%, 53%, and 51% of our total revenues for years ended December 31, 2006, 2005, and 2004, respectively. Our international
revenues represented 61% of our total revenues for the three months ended March 31, 2007. We categorize our revenues according to product shipment destination, which therefore does not necessarily reflect the ultimate country of installation.
Our international operations require significant management attention and financial resources.

There are certain risks inherent in our international
business activities including:



| |  |  | changes in foreign currency exchange rates;
| | - |  | -------------------------------------------



| |  |  | unexpected changes in politics and regulatory requirements;
| | - |  | -----------------------------------------------------------



| |  |  | tariffs and other trade barriers;
| | - |  | ---------------------------------



| |  |  | costs of localizing products for foreign countries;
| | - |  | ---------------------------------------------------



| |  |  | lack of acceptance of products in foreign countries;
| | - |  | ----------------------------------------------------



| |  |  | longer accounts receivable payment cycles;
| | - |  | ------------------------------------------



| |  |  | difficulties in building and managing international operations;
| | - |  | ---------------------------------------------------------------



| |  |  | tax issues, including restrictions on repatriating earnings;
| | - |  | ------------------------------------------------------------



| |  |  | weaker intellectual property protection in other countries;
| | - |  | -----------------------------------------------------------



| |  |  | economic weakness or currency related crises that may arise in different countries or geographic regions; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | the burden of complying with a wide variety of foreign laws.
| | - |  | ------------------------------------------------------------

These factors may have a material adverse effect on our future international sales and, consequently, on our business, results of operations, cash flows, or financial position

We rely heavily on revenues from our G2 and G2-based products. If demand for the G2 product declines, our revenues may be adversely affected.

Substantially all of our license revenues are derived from G2, a customizable object-oriented development and deployment platform for building expert operations management systems, and from software application
products based on G2 and other core technologies. Accordingly, our business and financial results are substantially dependent upon the continued customer acceptance and deployment of G2 and our other products. The timing of major G2 releases may
affect the timing of purchases of our products. We have introduced several G2-based products for building applications and may develop others. We believe that market acceptance of these products will be important to our future growth. There can be
no assurance that such products will achieve market acceptance or that new products will be successfully developed.

In addition, we rely on many of our
distribution partners to develop G2-based products for specialized markets. Accordingly, our business and financial results are also linked to the continued successful product development by our partners and market acceptance of such G2-based
products. Any decline in the demand for G2 and our other products, whether as a result of competitive products, price competition, the lack of success of our partners, technological change, the shift in customer demand toward complete solutions, or
other factors, could have a material adverse effect on our business, results of operations, cash flows, or financial position.

Our software is complex
and may contain undetected errors. Such errors could cause costly delays in product introduction or require costly software design modifications.

Complex software products such as those that we offer may contain unintended errors or failures commonly referred to as bugs. There can be no assurance that, despite significant testing by us and by current and potential
customers, errors will not be found in new products after commencement of commercial shipments. Although we have 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 our business, results of operations, cash flows, or financial position.



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Sales of our products are highly dependent on our customers capital expenditure budgets. If an economic downturn
causes our customers to reduce their capital expenditures, our revenues may be adversely affected.

Because capital expenditures are often viewed as
discretionary by organizations, sales of our products for capital budget projects are subject to general economic conditions. Future recessionary conditions in the industries that use our products may adversely affect our business, results of
operations, cash flows, or financial position.

Our business may be adversely affected if we fail to develop new products and respond to changes in
technology.

The market for our products is characterized by rapid technological change, evolving industry standards, changes in end-user requirements,
and frequent new product introductions and enhancements. Our future success will depend in part upon our ability to enhance our 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. We have from time to time experienced delays in introducing new products and product enhancements. There can be no assurance that we will not experience difficulties that
could delay or prevent the successful development, introduction and marketing of these new products and product enhancements. There also can be no assurance that we will successfully complete the development of new or enhanced products, that we will
successfully manage the transition to future versions of G2, or to successor technology, or that our future products will achieve market acceptance. In addition, the introduction of products embodying new technologies and the emergence of new
industry standards could render our 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 our 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 our existing products.

Our research and development in new reasoning technologies may not lead to profitable commercialization.

We developed a pre-release version of a new software reasoning platform, TrueManage, designed for handheld computing devices and targeted at application markets not
currently addressed by our G2 and G2-based products. We have also prototyped a TrueManage application product called LifeVisor, a cell phone device for self-management of chronic conditions such as diabetes and obesity. Development of TrueManage and
LifeVisor is complex, requiring specialized technical expertise. The targeted handheld computing markets experience rapid advancements in related technologies and applications. Our strategy was to distribute these products, particularly LifeVisor,
through other companies that have significantly larger presence and scale in the targeted markets than we do. We found that it would require significant funding to develop, launch, and build distribution channels for TrueManage and LifeVisor and
have therefore suspended development. There can be no assurance that we will be able to successfully complete the development of TrueManage and LifeVisor in the future. Our ability to use this technology and realize a return on this investment may
be limited.

Our stock price may be volatile and an investment in our common stock could suffer a decline in value.

The market price for our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control. These factors include:



| |  |  | actual or anticipated fluctuations in our operating results;
| | - |  | ------------------------------------------------------------



| |  |  | developments or disputes concerning proprietary rights;
| | - |  | -------------------------------------------------------



| |  |  | the loss of key management or technical personnel;
| | - |  | --------------------------------------------------



| |  |  | technological innovations or new products;
| | - |  | ------------------------------------------



| |  |  | governmental regulatory action;
| | - |  | -------------------------------



| |  |  | fluctuations in currency exchange rates;
| | - |  | ----------------------------------------



| |  |  | general conditions in the software industry;
| | - |  | --------------------------------------------



| |  |  | broad market fluctuations; and
| | - |  | ------------------------------



| |  |  | economic conditions in the United States or abroad.
| | - |  | ---------------------------------------------------

The stock market has recently experienced price and volume fluctuations. These fluctuations have particularly affected the market price of many software companies, often without regard to their operating performance.

Compliance with changing regulation of corporate governance and public disclosure may result in additional risks and expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ
rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases and, as a result, their application in practice may evolve over time as new
guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.



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We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to
comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and management time and attention. In particular, our efforts to comply with
Section 404 of Sarbanes-Oxley and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors audit of that assessment has required the commitment of significant
financial and managerial resources, and we expect our compliance efforts to require the continued commitment of significant resources. Additionally, if our efforts to comply with new or changed laws, regulations and standards differ from the
activities intended by regulatory or governing bodies, our reputation may be harmed, and we might be subject to sanctions or investigation by regulatory authorities, such as the SEC. Any such action could adversely affect our business and the market
price of our stock.

Our common stock is quoted on the Pink Sheets, which limits the liquidity and could negatively affect the value of our common
stock.

Our common stock is quoted on the Pink Sheets, which provides significantly less liquidity than a securities exchange, such as the New York
Stock Exchange, the American Stock Exchange, or the NASDAQ Global Market.

Purchasers of shares of our common stock may find it difficult to resell their
shares at prices quoted in the market or at all. There is currently a limited volume of trading in our common stock, and on some days there has been no trading activity at all. We cannot predict when or whether investor interest in our common stock
might lead to an increase in its market price or the development of a more active trading market or how liquid that market might become.

Additionally,
because our common stock is listed on the Pink Sheets, the liquidity of our common stock is impaired, not only in the number of shares that are bought and sold, but also through delays in the timing of transactions, and limited coverage by security
analysts and the news media, if any, of our company. As a result, prices for shares of our common stock may be lower than might otherwise prevail if our common stock was traded on a national securities exchange, like the New York Stock Exchange, the
American Stock Exchange or the NASDAQ Global Market.

Because we rely heavily upon proprietary technology, our business could be adversely affected if
we are unable to protect our proprietary technology or if third parties successfully assert infringement claims against us.

Our success is heavily
dependent upon our proprietary technology. We rely upon a combination of trade secret, contract, copyright, patent, and trademark law to protect our proprietary rights in our products and technology. We enter into confidentiality and/or license
agreements with our employees, contractors, third-party resellers, and end users and limit access to and distribution of our software, documentation, and other proprietary information. In addition, we have placed technical inhibitors in our 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 our products are distributed. There can be no assurance that the
steps taken by us to protect our proprietary technology will be adequate to prevent misappropriation of our 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.

Provisions in our corporate
documents and Delaware law could delay or prevent a change of control of the company, even if that change would be beneficial to our stockholders.

Our
certificate of incorporation and bylaws contain provisions that may make a change of control of the company difficult, even if it would be beneficial to our stockholders, including provisions governing the classification, nomination and removal of
directors, prohibiting stockholder action by written consent, regulating the ability of our stockholders to bring matters for action before annual stockholder meetings, and the authorization given to our board of directors to issue and set the terms
of preferred stock. In addition, Section 203 of the Delaware General Corporation Law would impose restrictions on mergers and other business combinations between us and any holder of 15 percent or more of our outstanding common stock.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

In the
third quarter of 1998, we began a program to repurchase up to 650,000 shares of our common stock on the open market. As of March 31, 2007, 501,300 shares had been repurchased at a cost of approximately $1,869,000. No shares were purchased in
2007, 2006 or 2005. The following table provides information about purchases by the company during the quarter ended March 31, 2007 of equity securities that are registered by the company pursuant to Section 12 of the Exchange Act:



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GENSYM PURCHASES OF EQUITY SECURITIES



|                  |  |                                                  |  |                            |   |                                                                                                          |         |                                                                                  |        
|----------------- |  | ------------------------------------------------ |  | -------------------------- | - | -------------------------------------------------------------------------------------------------------- | ------- | -------------------------------------------------------------------------------- | -------
|Period            |  | Total Number ofShares Purchasedduring Period (1) |  | Average PricePaid perShare |   | Total Number ofShares Purchasedsince Adoption ofProgram asPart of PubliclyAnnounced
Plansor Programs (2) |         | Maximum Number of Sharesthat May Yet Be
PurchasedUnder the Plans or Programs (3)
|01/01/07-01/31/07 |  | 0                                                |  | $                          |  |                                                                                                          | 501,300 |                                                                                  | 148,700
|02/01/07-02/28/07 |  | 0                                                |  |                            |  |                                                                                                          | 501,300 |                                                                                  | 148,700
|03/01/07-03/31/07 |  | 0                                                |  |                            |  |                                                                                                          | 501,300 |                                                                                  | 148,700

---

|(1) | We repurchased an aggregate of 501,300 shares of our common stock pursuant to the repurchase program that we publicly announced on July 1, 1998 (the Program).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Our board of directors approved the repurchase by us of up to an aggregate of 650,000 shares of our common stock pursuant to the Program. Unless terminated earlier by resolution of
our board of directors, the Program will expire when we have repurchased all shares authorized for repurchase thereunder.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | We do not anticipate making further purchases under this Program.
|--- | -----------------------------------------------------------------



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|ITEM 6. | Exhibits
|------- | --------

The following exhibits are filed as part of this Report
on Form 10-Q:



|              |  |                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                      
|31.1          |  | Certification of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|31.2          |  | Certification of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|32.1          |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                               
|              | 
|32.2          |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                               



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SIGNATURES

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



|                     |  |                                                                     
|-------------------- |  | --------------------------------------------------------------------
|                     |  | GENSYM CORPORATION                                                  
|                     |  | (Registrant)                                                        
|                     | 
|Dated: July 11, 2007 |  | /s/ STEPHEN D. ALLISON                                              
|                     |  | Stephen D. Allison                                                  
|                     |  | Chief Financial Officer (Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|              |  |                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                      
|31.1          |  | Certification of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|31.2          |  | Certification of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|32.1          |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                               
|              | 
|32.2          |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                               



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