##### 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 June 30, 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 August 8, 2007 there were 7,923,404 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 June 30, 2007 and December 31, 2006 (Unaudited)                           |  | 3 
|                             |  |                                                                                                            
|                             |  | Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006 (Unaudited) |  | 4 
|                             |  |                                                                                                            
|                             |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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                       |  | 11
|                             |  |                                                                                                            
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk Investment Portfolio                             |  | 18
|                             |  |                                                                                                            
|Item 4.                      |  | Controls and Procedures                                                                                     |  | 18
|                             | 
|Part IIOther Information    |  |                                                                                                            
|                             |  |                                                                                                            
|Item 1.                      |  | Legal Proceedings                                                                                           |  | 20
|                             |  |                                                                                                            
|Item 1A.                     |  | Risk Factors                                                                                                |  | 20
|                             |  |                                                                                                            
|Item 2.                      |  | Unregistered Sales of Equity Securities and Use of Proceeds.                                                |  | 28
|                             |  |                                                                                                            
|Item 3.                      |  |                                                                                                             |  |   
|                             |  |                                                                                                            
|Item 6.                      |  | Exhibits                                                                                                    |  | 30
|                             |  |                                                                                                            
|                             |  | Signatures                                                                                                  |  | 31
|                             |  |                                                                                                            
|                             |  | Exhibit Index                                                                                               |  | 32



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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)



|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                        |  | June 30,2007 |         |   | December 31,2006 |  
|ASSETS                                                                                                                                                                                                  |  |              |         |   |                  |   |         |  
|Current Assets:                                                                                                                                                                                         |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                                               |  | $            | 3,210   |   |                  | $ | 3,238   |  
|Accounts receivable, net of allowance for doubtful accounts of $42 at June 30, 2007 and $47 at December 31, 2006                                                                                        |  |              | 2,272   |   |                  |   | 2,952   |  
|Prepaid and other current assets                                                                                                                                                                        |  |              | 493     |   |                  |   | 453     |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                                                                                                    |  |              | 5,975   |   |                  |   | 6,643   |  
|                                                                                                                                                                                                        |  |             
|Property and equipment, net                                                                                                                                                                             |  |              | 464     |   |                  |   | 561     |  
|Deposits and other assets                                                                                                                                                                               |  |              | 125     |   |                  |   | 132     |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total Assets                                                                                                                                                                                            |  | $            | 6,564   |   |                  | $ | 7,336   |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                                                                   |  |              |         |   |                  |   |         |  
|Current Liabilities:                                                                                                                                                                                    |  |              |         |   |                  |   |         |  
|Accounts payable                                                                                                                                                                                        |  | $            | 157     |   |                  | $ | 500     |  
|Accrued expenses                                                                                                                                                                                        |  |              | 1,400   |   |                  |   | 1,855   |  
|Current portion of capital lease obligation                                                                                                                                                             |  |              | 82      |   |                  |   | 113     |  
|Deferred revenue                                                                                                                                                                                        |  |              | 4,318   |   |                  |   | 4,323   |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                                               |  |              | 5,957   |   |                  |   | 6,791   |  
|                                                                                                                                                                                                        |  |             
|Capital lease and other long term liabilities, net of current portion                                                                                                                                   |  |              | 124     |   |                  |   | 181     |  
|Long term deferred revenue                                                                                                                                                                              |  |              | 530     |   |                  |   | 826     |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total Liabilities                                                                                                                                                                                       |  |              | 6,611   |   |                  |   | 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8,215,523 and 8,210,441 shares in 2007 and 2006 respectively,
outstanding7,883,154 and 7,878,072 shares in 2007 and 2006, respectively |  |              | 82      |   |                  |   | 82      |  
|Capital in excess of par value                                                                                                                                                                          |  |              | 22,703  |   |                  |   | 22,686  |  
|Treasury stock332,369 shares in 2007 and 2006 at cost respectively                                                                                                                                     |  |              | (1,240  | ) |                  |   | (1,240  | )
|Accumulated deficit                                                                                                                                                                                     |  |              | (21,648 | ) |                  |   | (22,031 | )
|Accumulated other comprehensive income                                                                                                                                                                  |  |              | 56      |   |                  |   | 41      |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total stockholders deficit                                                                                                                                                                             |  |              | (47     | ) |                  |   | (462    | )
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Total liabilities and stockholders deficit                                                                                                                                                             |  | $            | 6,564   |   |                  | $ | 7,336   |  
|                                                                                                                                                                                                        |  |              |         |   |                  |   |         |  

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



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##### Table of Contents

GENSYM CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share
amounts)



|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|-------------------------------------------------- |  | -------------------------- | ----- | ------------------------ | ---- | - | ----- |  | - | ----- | - |  | - | ----- | -
|                                                   |  | Three Months EndedJune 30, |       | Six Months EndedJune 30, |     
|                                                   |  | 2007                       |       |                          | 2006 |   | 2007  |  |   | 2006  |  
|Revenues:                                          |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Product                                            |  | $                          | 1,446 |                          |      | $ | 1,628 |  | $ | 3,051 |   |  | $ | 3,320 |  
|Services                                           |  |                            | 2,521 |                          |      |   | 2,824 |  |   | 5,009 |   |  |   | 5,020 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Total revenues                                     |  |                            | 3,967 |                          |      |   | 4,452 |  |   | 8,060 |   |  |   | 8,340 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Cost of revenues:                                  |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Product                                            |  |                            | 80    |                          |      |   | 96    |  |   | 197   |   |  |   | 227   |  
|Services                                           |  |                            | 1,012 |                          |      |   | 1,240 |  |   | 2,137 |   |  |   | 2,098 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Total cost of revenues                             |  |                            | 1,092 |                          |      |   | 1,336 |  |   | 2,334 |   |  |   | 2,325 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Gross profit                                       |  |                            | 2,875 |                          |      |   | 3,116 |  |   | 5,726 |   |  |   | 6,015 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Operating expenses:                                |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Sales and marketing                                |  |                            | 777   |                          |      |   | 1,113 |  |   | 1,487 |   |  |   | 2,417 |  
|Research and development                           |  |                            | 645   |                          |      |   | 739   |  |   | 1,317 |   |  |   | 1,700 |  
|General and administrative                         |  |                            | 1,208 |                          |      |   | 1,196 |  |   | 2,432 |   |  |   | 2,293 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Total operating expenses                           |  |                            | 2,630 |                          |      |   | 3,048 |  |   | 5,236 |   |  |   | 6,410 |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Operating income (loss)                            |  |                            | 245   |                          |      |   | 68    |  |   | 490   |   |  |   | (395  | )
|Other (expense) income, net                        |  |                            | (10   | )                        |      |   | 33    |  |   | (21   | ) |  |   | 25    |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Income (loss) before provision for income taxes    |  |                            | 235   |                          |      |   | 101   |  |   | 469   |   |  |   | (370  | )
|Provision for income taxes                         |  |                            | 31    |                          |      |   | 7     |  |   | 86    |   |  |   | 9     |  
|                                                   |  |                            |       |                          |      |   |       |  |   |       |   |  |   |       |  
|Net income (loss)                                  |  | $                          | 204   |                          |      | $ | 94    |  | $ | 383   |   |  | $ | (379  | )
|                                                   |  |                            |       |                         
|Basic earning (loss) per share                     |  | $                          | 0.03  |                          |      | $ | 0.01  |  | $ | 0.05  |   |  | $ | (0.05 | )
|Diluted earnings (loss) per share                  |  | $                          | 0.03  |                          |      | $ | 0.01  |  | $ | 0.05  |   |  | $ | (0.05 | )
|                                                   |  |                            |       |                         
|Basic weighted average common shares outstanding   |  |                            | 7,879 |                          |      |   | 7,463 |  |   | 7,879 |   |  |   | 7,450 |  
|Diluted weighted average common shares outstanding |  |                            | 8,128 |                          |      |   | 8,122 |  |   | 8,091 |   |  |   | 7,450 |  

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



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##### Table of Contents

GENSYM CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



|                                                                                         |  |                          |       |   |      |   |       |  
|---------------------------------------------------------------------------------------- |  | ------------------------ | ----- | - | ---- | - | ----- | -
|                                                                                         |  | Six Months EndedJune 30, |      
|                                                                                         |  | 2007                     |       |   | 2006 |  
|Cash Flows from Operating Activities:                                                    |  |                          |       |   |      |   |       |  
|Net income (loss)                                                                        |  | $                        | 383   |   |      | $ | (379  | )
|Adjustments to reconcile net (loss) income to net cash provided by operating activities: |  |                          |       |   |      |   |       |  
|Depreciation and amortization                                                            |  |                          | 162   |   |      |   | 178   |  
|Stock-based compensation                                                                 |  |                          | 15    |   |      |   | 177   |  
|Reversal of provision for bad debt                                                       |  |                          | (5    | ) |      |   | (6    | )
|Changes in assets and liabilities:                                                       |  |                          |       |   |      |   |       |  
|Accounts receivable                                                                      |  |                          | 685   |   |      |   | 721   |  
|Prepaid expenses and other current assets                                                |  |                          | (40   | ) |      |   | (199  | )
|Accounts payable                                                                         |  |                          | (343  | ) |      |   | (46   | )
|Accrued expenses                                                                         |  |                          | (455  | ) |      |   | 231   |  
|Deposits and other assets                                                                |  |                          | 7     |   |      |   |      |  
|Deferred revenue                                                                         |  |                          | (301  | ) |      |   | 207   |  
|Other liabilities                                                                        |  |                          |      |   |      |   | 49    |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Net cash provided by operating activities                                                |  |                          | 108   |   |      |   | 933   |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Cash Flows from Investing Activities:                                                    |  |                          |       |   |      |   |       |  
|Purchases of property and equipment                                                      |  |                          | (42   | ) |      |   | (168  | )
|                                                                                         |  |                          |       |   |      |   |       |  
|Net cash used in investing activities                                                    |  |                          | (42   | ) |      |   | (168  | )
|                                                                                         |  |                          |       |   |      |   |       |  
|Cash Flows From Financing Activities:                                                    |  |                          |       |   |      |   |       |  
|Principal payments on capital lease obligations                                          |  |                          | (111  | ) |      |   | (53   | )
|Proceeds from exercise of stock options                                                  |  |                          | 2     |   |      |   | 20    |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Net cash used in financing activities                                                    |  |                          | (109  | ) |      |   | (33   | )
|                                                                                         |  |                          |       |   |      |   |       |  
|Effect of Exchange Rate Changes on Cash                                                  |  |                          | 15    |   |      |   | 17    |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Net (Decrease) Increase in Cash and Cash Equivalents                                     |  |                          | (28   | ) |      |   | 749   |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Cash and Cash Equivalents, Beginning of Period                                           |  |                          | 3,238 |   |      |   | 3,176 |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Cash and Cash Equivalents, End of Period                                                 |  | $                        | 3,210 |   |      | $ | 3,925 |  
|                                                                                         |  |                          |       |   |      |   |       |  
|Cash paid for income taxes                                                               |  | $                        | 8     |   |      | $ | 7     |  
|                                                                                         |  |                         
|Cash paid for interest                                                                   |  | $                        | 8     |   |      | $ | 10    |  
|                                                                                         |  |                         
|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 June 30, 2007 and our results of operations for the three- and six-month periods and cash flows for the six-month periods ended June 30, 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- and six-month periods ended June 30, 2007, we generated operating and net income, but did not achieve 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 of 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



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued

(Unaudited)



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.

4. Comprehensive Loss

The components of comprehensive income (loss)
for the three- and six-month periods ended June 30, 2007 and 2006 are as follows (in thousands)



|                                        |  |                            |     |      |                          |    |      |  |      |     |  |   |      |  
|--------------------------------------- |  | -------------------------- | --- | ---- | ------------------------ | -- | ---- |  | ---- | --- |  | - | ---- | -
|                                        |  | Three Months EndedJune 30, |     |      | Six Months EndedJune 30, |   
|                                        |  | 2007                       |     | 2006 |                          |    | 2007 |  | 2006 |    
|Net income (loss)                       |  | $                          | 204 |      | $                        | 94 |      |  | $    | 383 |  | $ | (379 | )
|Other comprehensive (loss) income:      |  |                            |     |      |                          |    |      |  |      |     |  |   |      |  
|Foreign currency translation adjustment |  |                            | 5   |      |                          | (1 | )    |  |      | 15  |  |   | 17   |  
|                                        |  |                            |     |      |                          |    |      |  |      |     |  |   |      |  
|Comprehensive income (loss)             |  | $                          | 209 |      | $                        | 93 |      |  | $    | 398 |  | $ | (362 | )
|                                        |  |                            |     |      |                          |    |      |  |      |     |  |   |      |  

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 EndedJune 30, |  | Six Months EndedJune 30,
|                                             |  | 2007                       |  | 2006                     |  | 2007  |  | 2006 
|Weighted average common shares outstanding   |  | 7,879                      |  | 7,463                    |  | 7,879 |  | 7,450
|Additional dilutive common stock equivalents |  | 249                        |  | 659                      |  | 212   |  |     
|                                             |  |                            |  |                          |  |       |  |      
|Diluted weighted average shares              |  | 8,128                      |  | 8,122                    |  | 8,091 |  | 7,450
|                                             |  |                            |  |                          |  |       |  |      

For the three-month periods ended June 30, 2007 and 2006, options to purchase 252,126 and 197,126 shares of
common stock, respectively, were outstanding, but 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. For the six-month periods ended June 30,
2007 and 2006, options to purchase 252,126 and 1,598,922 shares of common stock, respectively, were outstanding, but not included in the computation of diluted earnings per share because in the 2007 period the exercise price per share was greater
than the average market price per share and in the 2006 period 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 $5,000 and $73,000 of stock-based compensation on our consolidated condensed statements of operations
for the three- months ended June 30, 2007 and 2006, respectively and $15,000 and $167,000 for the six months ended June 30, 2007 and 2006, respectively. The adoption of SFAS No. 123R had no effect on cash flow from operations for the
three- and six- months ended June 30, 2007. The stock-based compensation for the three and six months ended June 30, 2007 and 2006 is included in the following expense categories (in thousands):



|                           |  |                            |   |                          |   |      |  |      |    |  |   |    
|-------------------------- |  | -------------------------- | - | ------------------------ | - | ---- |  | ---- | -- |  | - | ---
|                           |  | Three Months EndedJune 30, |   | Six Months EndedJune 30,
|                           |  | 2007                       |   | 2006                     |   | 2007 |  | 2006
|Cost of service and other  |  | $                          |  |                          | $ | 3    |  | $    |   |  | $ | 6  
|Selling and marketing      |  |                            | 4 |                          |   | 7    |  |      | 8  |  |   | 15 
|Research and development   |  |                            |  |                          |   | 4    |  |      |   |  |   | 10 
|General and administrative |  |                            | 1 |                          |   | 59   |  |      | 7  |  |   | 136
|                           |  |                            |   |                          |   |      |  |      |    |  |   |    
|                           |  | $                          | 5 |                          | $ | 73   |  | $    | 15 |  | $ | 167
|                           |  |                            |   |                          |   |      |  |      |    |  |   |    



7



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued

(Unaudited)



During the six- months ended June 30, 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 month periods ended June 30, 2007 and 2006
or during the six months ended June 30, 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- and six month periods ended June 30, 2007. The weighted-average fair value of the options granted for the three- and six- month periods ended
June 30, 2006 were $2.09 and $1.68 using the following assumptions:



|                                 |  |                          |  |         |  
|-------------------------------- |  | ------------------------ |  | ------- | -
|                                 |  | Six Months EndedJune 30, | 
|                                 |  | 2007                     |  | 2006    |  
|Average risk free interest rates |  | n/a                      |  | 5.00    | %
|Expected dividend yield          |  | n/a                      |  | None    |  
|Expected life                    |  | n/a                      |  | 7 Years |  
|Expected volatility              |  | n/a                      |  | 130     | %

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 six months ended June 30, 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
|                                 |  |                        |   |  |                                |      |                                                   |      |                                 |   |    
|Granted                          |  |                       |   |  |                                |     |                                                   |      |                                 |   |    
|Exercised                        |  | (4,750                 | ) |  |                                | 0.60 |                                                   |      |                                 |   |    
|Forfeited                        |  | (41,400                | ) |  |                                | 3.30 |                                                   |      |                                 |   |    
|                                 |  |                        |   |  |                                |      |                                                   |      |                                 |   |    
|Outstanding at June 30, 2007     |  | 774,440                |   |  | $                              | 1.45 |                                                   | 5.58 |                                 | $ | 863
|                                 |  |                        |   |  |                                |      |                                                   |      |                                 |   |    
|Exercisable at June 30, 2007     |  | 743,941                |   |  | $                              | 1.45 |                                                   | 5.61 |                                 | $ | 839
|                                 |  |                        |   |  |                                |      |                                                   |      |                                 |   |    



8



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued

(Unaudited)



As of June 30, 2007 and 2006 we had $19,573 and $494,000 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
June 30, 2007 and 2006 was $9,300 and $41,000, respectively. The intrinsic value of options exercised for the six months ended June 30, 2007 and 2006 was $9,300 and 53,000, respectively.

(7) Restructuring Charge

In August 2006, our board of directors
approved a restructuring plan that included a workforce reduction and the closure of two sales offices. The restructuring plan consisted of reductions in employee headcount totaling 15 employees from all operating groups and geographic areas. In
accordance with this plan, we recorded a restructuring charge of $0.5 million during the three months ended September 30, 2006. Substantially all of the charge represents amounts to be paid in cash. The charge was based on estimates of the cost
of the workforce reduction program, including special termination benefits, settlement and involuntary severance benefits related to postretirement benefit plans in Europe, and related legal costs.

At December 31, 2006 there remained an accrual of $0.2 million relating to this restructuring plan which we expect to pay by the end of 2007. The following table
summarizes our restructuring activity for the six months ended June 30, 2007:



|                                |  |                        |      |  
|------------------------------- |  | ---------------------- | ---- | -
|                                |  | RestructuringLiability |     
|Balance as of December 31, 2006 |  | $                      | 248  |  
|Cash payments                   |  |                        | (   | )
|                                |  |                        |      |  
|Balance as of March 31, 2007    |  |                        | 248  |  
|Cash payments                   |  |                        | (248 | )
|                                |  |                        |      |  
|Balance as of June 30, 2007     |  |                        |     |  

8. 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 MonthsEndedJune 30, |   |  | Six MonthsEndedJune 30, |  
|               |  | 2007                      |   |  | 2006                    |   |  | 2007 |   |  | 2006 |  
|United States  |  | 38                        | % |  | 53                      | % |  | 39   | % |  | 50   | %
|Sweden         |  | 9                         | % |  | 8                       | % |  | 10   | % |  | 8    | %
|Italy          |  | 9                         | % |  | 2                       | % |  | 10   | % |  | 5    | %
|Asia           |  | 7                         | % |  | 6                       | % |  | 7    | % |  | 8    | %
|Rest of Europe |  | 26                        | % |  | 17                      | % |  | 23   | % |  | 16   | %
|Rest of World  |  | 11                        | % |  | 14                      | % |  | 11   | % |  | 13   | %
|               |  |                           |   |  |                         |   |  |      |   |  |      |  
|               |  | 100                       | % |  | 100                     | % |  | 100  | % |  | 100  | %
|               |  |                           |   |  |                         |   |  |      |   |  |      |  



9



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##### Table of Contents

GENSYM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued

(Unaudited)



One customer accounted for 10% and 17% of revenue for the three-month period ended June 30, 2007 and 2006
respectively. One customer accounted for 10% and 14% of revenue for the six-month period ended June 30, 2007 and 2006 respectively.

The following
table presents our long-lived assets, net of depreciation and amortization, as of June 30, 2007 and December 31, 2006 (in thousands):



|              |  |              |     |                  |   |    
|------------- |  | ------------ | --- | ---------------- | - | ---
|              |  | June 30,2007 |     | December 31,2006
|United States |  | $            | 423 |                  | $ | 523
|Europe        |  |              | 41  |                  |   | 38 
|              |  |              |     |                  |   |    
|Total         |  | $            | 464 |                  | $ | 561



10



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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.                                                             



11



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##### Table of Contents

|              |  |                                                                                                    
|------------- |  | ---------------------------------------------------------------------------------------------------
|Product       |  | Application                                                                                        
|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.                           

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 MonthsEndedJune 30, |   |  | Six MonthsEndedJune 30, |  
|                                    |  | 2007                      |   |  | 2006                    |   |  | 2007 |   |  | 2006 |  
|Product license sales               |  | 36                        | % |  | 37                      | % |  | 38   | % |  | 40   | %
|Consulting and educational services |  | 20                        | % |  | 23                      | % |  | 20   | % |  | 20   | %
|Customer support services           |  | 44                        | % |  | 40                      | % |  | 42   | % |  | 40   | %
|                                    |  |                           |   |  |                         |   |  |      |   |  |      |  
|                                    |  | 100                       | % |  | 100                     | % |  | 100  | % |  | 100  | %
|                                    |  |                           |   |  |                         |   |  |      |   |  |      |  



12



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##### Table of Contents

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 Ericsson, Siemens, 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. The preparation of these financial statements requires us to make estimates and judgments
that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as 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 are believed 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.

We believe the following revenue recognition accounting policy is critical to an understanding of our consolidated financial statements.

Revenue Recognition

We derive revenues from two primary sources: (1) product licenses and (2) services revenues, which include
maintenance, consulting, and education revenues. While the basis for software revenue recognition is substantially governed by the provisions of Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2), and Statement of
Position No. 98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions, (SOP 98-9), Statement of Position No. 81-1, Accounting for Construction-type and Certain Production-type Contracts (SOP
81-1), as issued by the American Institute of Certified Public Accountants, and SEC Staff Accounting Bulletin 104, Revenue Recognition (SAB 104), we exercise judgment and use estimates in connection with the determination of the amount of
software license and services revenues to be recognized in each accounting period.

For software license arrangements that do not require significant
modification or customization of the underlying software, we recognize license revenue 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. A significant majority of our license revenues are recognized in this manner. For term licenses that include the right to use software bundled with maintenance for the duration of the term, we
recognize revenue ratably over such term.

We assess whether fees are fixed or determinable and free of contingencies or significant uncertainties at the
time of sale and recognize revenue if all other revenue recognition criteria are met. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer.

Our license arrangements generally do not include acceptance provisions. However, if an arrangement includes an acceptance provision, revenue is recognized upon the
earlier of receipt of a written customer acceptance or expiration of the acceptance period.

Our software is distributed directly through our sales force
and indirectly through alliances with resellers. Revenue arrangements with resellers are recognized upon delivery of the software to the reseller provided all other revenue recognition criteria, as specified above, have been satisfied. For resellers
with rights of return, we recognize revenue upon delivery of the software to the end user.

We account for software license revenues included in multiple
element arrangements using the residual method prescribed in SOP 98-9. Under the residual method, the fair value of the undelivered elements, such as maintenance, consulting, and education services, based on vendor specific objective evidence
is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements, generally, the software licenses. If evidence of the fair value of one or more of the undelivered services does not exist, revenues are deferred and
recognized when delivery of those services occurs or fair value can be established. We determine vendor specific objective evidence of fair value for services revenues based upon our current pricing for those services when sold separately and vendor
specific objective evidence of fair value for maintenance services is measured by substantive renewal rates. Our current pricing practices are influenced primarily by product type, purchase volume, maintenance term, and customer location.



Our software arrangements may include consulting services sold separately under
consulting engagement contracts that generally include implementation. These services may also be provided completely or partially by independent third-parties experienced in providing such consulting and implementation in coordination with
dedicated customer personnel. Revenues from these arrangements are generally accounted for separately from the license revenue because they meet the criteria for separate accounting, as defined in SOP 97-2. The more significant factors considered in
determining whether the revenue should be accounted for separately include the nature of services, such as consideration of whether the services are essential to the functionality of the licensed product, degree of risk, availability of services
from other vendors, timing of payments and impact of milestones or acceptance criteria on the realizability of the software license fee.

For projects that
require customization and development of the software, we account for the software and services as prescribed in SOP 81-1 using the percentage-of-completion method (using input measures, generally labor hours). We also have a limited number of
contracts of this type that contain prescribed performance milestones, where we use these output measures to recognize revenue as permitted by SOP 81-1. In these cases, we recognize the revenue when the milestones are achieved and accepted by the
customer.

Maintenance services generally include rights to unspecified upgrades, when and if available, telephone support, updates, and bug fixes.
Maintenance revenue is recognized ratably over the term of the maintenance contract on a straight-line basis when all the revenue recognition requirements are met. Historically we have not offered any specified upgrade rights to an existing product.

Consulting services that are sold separately from license revenue are generally recognized as the services are performed on a time and materials basis.
Consulting revenues for fixed-price contracts are recognized using a proportional performance model. If there is a significant uncertainty about the project completion or receipt of payment for the consulting services, revenue is deferred until the
uncertainty is sufficiently resolved.

Education revenues are recognized as the related training services are provided.

Other Critical Accounting Polices

In addition to our revenue
recognition accounting policy discussed above, we believe the following accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 are also critical to an understanding of our consolidated financial
statements and involve the more significant judgments and estimates used in the preparation of our consolidated financial statements:



| |  |  | stock based compensation;
| | - |  | -------------------------



| |  |  | accounts receivable and allowance for doubtful accounts;
| | - |  | --------------------------------------------------------



| |  |  | foreign currency translation; and
| | - |  | ---------------------------------



| |  |  | accounting for income taxes.
| | - |  | ----------------------------

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

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 EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                                                |  | 2007                       |   |  | 2006                     |   |  | 2007 |   |  | 2006 |   
|Revenues:                                       |  |                            |   |  |                          |   |  |      |   |  |      |   
|Product                                         |  | 36                         | % |  | 37                       | % |  | 38   | % |  | 40   | % 
|Services                                        |  | 64                         | % |  | 63                       | % |  | 62   | % |  | 60   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Total revenues                                  |  | 100                        | % |  | 100                      | % |  | 100  | % |  | 100  | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Cost of revenues:                               |  |                            |   |  |                          |   |  |      |   |  |      |   
|Product                                         |  | 2                          | % |  | 2                        | % |  | 2    | % |  | 3    | % 
|Services                                        |  | 26                         | % |  | 28                       | % |  | 27   | % |  | 25   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Total cost of revenues                          |  | 28                         | % |  | 30                       | % |  | 29   | % |  | 28   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Gross profit                                    |  | 72                         | % |  | 70                       | % |  | 71   | % |  | 72   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Operating expenses:                             |  |                            |   |  |                          |   |  |      |   |  |      |   
|Sales and marketing                             |  | 20                         | % |  | 25                       | % |  | 19   | % |  | 29   | % 
|Research and development                        |  | 16                         | % |  | 16                       | % |  | 16   | % |  | 20   | % 
|General and administrative                      |  | 30                         | % |  | 27                       | % |  | 30   | % |  | 28   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Total operating expenses                        |  | 66                         | % |  | 68                       | % |  | 65   | % |  | 77   | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Operating income (loss)                         |  | 6                          | % |  | 2                        | % |  | 6    | % |  | (5   | )%
|                                                |  |                            |   | 
|Other (expense) income, net                     |  |                           | % |  |                         | % |  |     | % |  |     | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Income (loss) before provision for income taxes |  | 6                          | % |  | 2                        | % |  | 6    | % |  | (5   | )%
|Provision for income taxes                      |  | 1                          | % |  |                         | % |  | 1    | % |  |     | % 
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   
|Net income (loss)                               |  | 5                          | % |  | 2                        | % |  | 5    | % |  | (5   | )%
|                                                |  |                            |   |  |                          |   |  |      |   |  |      |   



13



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##### Table of Contents

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- and six- month periods ended June 30, 2007 and 2006 were as follows:



|              |  |                             |       |  |                           |   |  |      |       |  |      |   |  |   |       |  |    |   |  |   |       |  |    |  
|------------- |  | --------------------------- | ----- |  | ------------------------- | - |  | ---- | ----- |  | ---- | - |  | - | ----- |  | -- | - |  | - | ----- |  | -- | -
|              |  | Three Months Ended June 30, |       |  | Six Months Ended June 30, |  
|              |  | 2007                        |       |  | 2006                      |   |  | 2007 |       |  | 2006 |  
|U.S.          |  | $                           | 1,505 |  | 38                        | % |  | $    | 2,376 |  | 53   | % |  | $ | 3,106 |  | 39 | % |  | $ | 4,193 |  | 50 | %
|International |  |                             | 2,462 |  | 62                        | % |  |      | 2,076 |  | 47   | % |  |   | 4,954 |  | 61 | % |  |   | 4,147 |  | 50 | %
|              |  |                             |       |  |                           |   |  |      |       |  |      |   |  |   |       |  |    |   |  |   |       |  |    |  
|              |  | $                           | 3,967 |  |                           |   |  | $    | 4,452 |  |      |   |  | $ | 8,060 |  |    |   |  | $ | 8,340 |  |    |  

The overall decrease in revenue of $0.5 million or 11% between the three-months ended June 30, 2007 and the
same period in 2006 was primarily the result of a decrease in license sales and decrease in consulting projects. The overall decrease in revenue of $0.3 million or 3% between the six-months ended June 30, 2007 and the same period in 2006 was
primarily the result of a decrease in license sales.

The overall decrease in U.S. revenues was the result of a decrease in license and consulting revenues
for the three- and six-months ended June 30, 2007 as compared to the same periods in 2006. The increase in international revenues for the three- and six- month period ended June 30, 2007 was primarily a result of an increase in consulting
projects.

Our worldwide product and service revenues for the three- and six- month periods ended June 30, 2007 and 2006 were as follows:



|               |  |                            |       |                          |   |       |  |      |       |  |   |      
|-------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|               |  | Three Months Ended June 30 |       | Six Months Ended June 30
|               |  | 2007                       |       | 2006                     |   | 2007  |  | 2006
|Revenues:      |  |                            |       |                          |   |       |  |      |       |  |   |      
|Product        |  | $                          | 1,446 |                          | $ | 1,628 |  | $    | 3,051 |  | $ | 3,320
|Services       |  |                            | 2,521 |                          |   | 2,824 |  |      | 5,009 |  |   | 5,020
|               |  |                            |       |                          |   |       |  |      |       |  |   |      
|Total Revenues |  | $                          | 3,967 |                          | $ | 4,452 |  | $    | 8,060 |  | $ | 8,340

Product revenues for the three months ended June 30, 2007 decreased by $0.2 million, or 11%, as compared to
the same period in 2006 due to a reduction in license bookings. Product revenues for the six months ended June 30, 2007 decreased by $0.3 million, or 8%, as compared to the same period in 2006 due to a reduction in license bookings.

Services revenues for the three months ended June 30, 2007 decreased $0.3 million, or 11%, as compared to the same periods in 2006. This increase was mainly
attributable to a decrease in U.S. government consulting and training orders during the quarter, a decrease in license maintenance revenue from orders placed in prior periods, partially offset by an increase in European consulting projects. Service
revenues for the six months ended June 30, 2007 remained relatively the same as compared to the same period in 2006. This was the result of a decrease in U.S. government consulting projects offset by an increase in European consulting projects.

We had one customer that accounted for 10% and 17% of revenue for the three-month period ended June 30, 2007 and 2006 respectively. We had one
customer that accounted for 10% and 14% of revenue for the six-month period ended June 30, 2007 and 2006 respectively.



14



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##### Table of Contents

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
June 30, 2007 and 2006 were as follows:



|                  |  |                            |       |                          |   |       |  |      |       |  |   |      
|----------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                  |  | Three Months Ended June 30 |       | Six Months Ended June 30
|                  |  | 2007                       |       | 2006                     |   | 2007  |  | 2006
|Cost of Revenues: |  |                            |       |                          |   |       |  |      |       |  |   |      
|Product           |  | $                          | 80    |                          | $ | 96    |  | $    | 197   |  | $ | 227  
|Services          |  |                            | 1,012 |                          |   | 1,240 |  |      | 2,137 |  |   | 2,098
|                  |  |                            |       |                          |   |       |  |      |       |  |   |      
|Total Revenues    |  | $                          | 1,092 |                          | $ | 1,336 |  | $    | 2,334 |  | $ | 2,325

Product costs remained consistent for the three- and six- months ended June 30, 2007 as compared to the same
periods in 2006.

Service costs decreased $0.2 million, or 18%, for the three months ended June 30, 2007 as compared to the same period in 2006. This
decrease was primarily attributable to $0.1 decrease in salary costs due to a reduction in personnel as a result of our restructuring in August 2006, and a $0.1 million decrease in costs associated with a long term contract that was deferred in the
second quarter of 2006 with no similar deferral in 2007. Service costs remained consistent for the six months ended June 30, 2007 as compared to the same period in 2006. This was primarily attributable to a $0.2 million decrease in salary costs
due to a reduction in personnel as a result of our restructuring in August 2006, offset by a $0.1 million increase in costs associated with a long term contract that was deferred in 2006 with no similar deferral in 2007, and a $0.1 million increase
in cost for contractors based on specialized technical requirements on consulting projects.

Gross margin percentages for the three- and six- month periods
ended June 30, 2007 and 2006 were as follows:



|               |  |                            |   |  |                          |   |  |      |   |  |      |  
|-------------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|               |  | Three Months Ended June 30 |   |  | Six Months Ended June 30 |  
|               |  | 2007                       |   |  | 2006                     |   |  | 2007 |   |  | 2006 |  
|Gross margins: |  |                            |   |  |                          |   |  |      |   |  |      |  
|Product        |  | 95                         | % |  | 94                       | % |  | 94   | % |  | 93   | %
|Services       |  | 60                         | % |  | 56                       | % |  | 57   | % |  | 58   | %
|               |  |                            |   |  |                          |   |  |      |   |  |      |  
|Total          |  | 72                         | % |  | 70                       | % |  | 71   | % |  | 72   | %

Our gross margin on product remained relatively consistent the same, at 95% and 94%, during the three-month period
and 94% and 93% for the six-month period ended June 30, 2007 as compared to the same periods 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 increased 4% from 56% to 60% for the
three-month period and decreased 1% from 58% to 57% for the six-month period ended June 30, 2007 as compared to the same periods in 2006. Our service expenses changed as a percentage of our revenue based on the increased and decreased costs
identified above.

Operating Expenses



|                           |  |                            |       |                          |   |       |  |      |       |  |   |      
|-------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                           |  | Three Months Ended June 30 |       | Six Months Ended June 30
|                           |  | 2007                       |       | 2006                     |   | 2007  |  | 2006
|Operating expense:         |  |                            |       |                          |   |       |  |      |       |  |   |      
|Sales and marketing        |  | $                          | 777   |                          | $ | 1,113 |  | $    | 1,487 |  | $ | 2,417
|Research and development   |  |                            | 645   |                          |   | 739   |  |      | 1,317 |  |   | 1,700
|General and administrative |  |                            | 1,208 |                          |   | 1,196 |  |      | 2,432 |  |   | 2,293
|                           |  |                            |       |                          |   |       |  |      |       |  |   |      
|Total operating expense    |  | $                          | 2,630 |                          | $ | 3,048 |  | $    | 5,236 |  | $ | 6,410



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##### Table of Contents

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 June 30, 2007 were $0.8 million, a
decrease of $0.3 million, or 30%, 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 ten less personnel as a result of our restructuring plan executed in
August 2006. These expenses for the six-month period ended June 30, 2007 were $1.5 million, a decrease of $1.0 million or 38% as compared to the same period in 2006. The decrease was primarily attributable to a $0.6 million decrease in
personnel expense as there were ten less personnel as a result of our restructuring plan executed in August 2006, a $0.2 million decrease in consultants for external sales and marketing projects, and a $0.1 decrease in marketing due to a user
conference held in 2006 that was not repeated in 2007.

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 June 30, 2007 was $0.6 million, down $0.1 million or 13% as compared to the same period in 2006. This was primarily the result of a decrease
of $0.1 million in personnel expense as there were six less personnel as a result of our restructuring plan executed in August 2006. Total research and development expenses for the six-months ended June 30, 2007 was $1.3 million, down $0.4
million or 23% as compared to the same period in 2006. This was primarily the result of a decrease of $0.3 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 June 30, 2007 remained consistent at $1.2 million, as compared to
the same period in 2006. This was the result of a decrease of $0.2 million of legal expenses, a decrease of $.01 million for deferred compensation, offset by a $0.2 million increase in contractor support to augment finance staff during the
restatement, and a $0.1 million increase in accounting fees in support of the restatement process. These expenses for the six months ended June 30, 2007 were $2.4 million, up $0.1 million or 6% as compared to the same period in 2006. This
increase was primarily the result of a $0.5 million increase in contractor support in support of the restatement, a $0.1 million increase in accounting fees in support of the restatement process, partially offset by a decrease of $0.3 in personnel
costs, a $0.1 million decrease in legal fees and a $0.1 million decrease in deferred compensation.

Other Income, Expenses

Other expenses, net for the three-months ended June 30, 2007 were $10,000, a decrease, compared to other income, net of $33,000 for the same
period in 2006. The decrease is primarily due to foreign exchange rate fluctuations. Other expenses, net for the six-months ended June 30, 2007 were $21,000, compared to other income, net of $25,000 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 June 30, 2007 was $31,000, compared to $7,000 for the same period in 2006. Provision for income taxes
for the six-months ended June 30, 2007 was $86,000, compared to $9,000 for the same period in 2006.



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##### Table of Contents

Liquidity and Capital Resources

Our June 30, 2007 cash and cash equivalents remained the same at $3.2 million, as compared to December 31, 2006.

For the six months ended June 30, 2007, we had $0.1 million provided by operating activities, $0.04 million used in investing activities and $0.1 million used in financing activities.

Cash flows provided by operations were $0.1 million for the six-month periods ended June 30, 2007 as compared to $0.9 million provided by operations in the same
period in 2006.

Cash flows used in investing activities were $0.04 million and $0.2 million for the six-month periods ended June 30, 2007 and 2006,
respectively, and were primarily used for purchases of property and equipment.

Cash flows used in financing activities were $0.1 million and $0.03 million
for the six-month periods ended June 30, 2007 and 2006, and were primarily used for principal payments on capital lease obligations.

We currently
finance our operations, along with capital expenditures, primarily through cash flows from operations. Our lease commitments consist of operating leases for our facilities and 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 June 30, 2007 are as follows:



|                                              |  |                 |       |               |   |    
|--------------------------------------------- |  | --------------- | ----- | ------------- | - | ---
|                                              |  | (in thousands) 
|For the period ended December 31,             |  | OperatingLeases |       | CapitalLeases
|2007                                          |  | $               | 300   |               |   | 62 
|2008                                          |  |                 | 566   |               |   | 44 
|2009                                          |  |                 | 517   |               |   | 28 
|2010                                          |  |                 | 510   |               |   | 2  
|2011                                          |  |                 | 221   |               |   |   
|Thereafter                                    |  |                 | 217   |               |   |   
|                                              |  |                 |       |               |   |    
|Total minimum lease payments                  |  | $               | 2,331 |               | $ | 136
|Less: Amount representing interest and fees   |  |                 |       |               |   | 14 
|                                              |  |                 |       |               |   |    
|Present value of minimum lease payments       |  |                 |       |               |   | 122
|Less: Current portion                         |  |                 |       |               |   | 82 
|                                              |  |                 |       |               |   |    
|Long-term portion of capital lease obligation |  |                 |       |               | $ | 40 

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.



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##### Table of Contents

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 June 30, 2007, 501,300 shares had been repurchased at a cost of approximately $1,869,000. No shares were
repurchased in 2007, 2006 or 2005. As of June 30, 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 $ 15,824 and $72,755 to Integration Objects, Inc. during the three- and six- month periods ended June 30, 2007.

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
|------- | ----------------------------------------------------------

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 June 30, 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 June 30, 2007. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, means



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##### Table of Contents

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 June 30, 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 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
| | - |  | ---------------------------------------------------------------



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##### Table of Contents

| |  |  | 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 June 30, 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.

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.



20



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##### Table of Contents

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.

We have identified material weaknesses in our disclosure controls and procedures and our internal control over financial reporting as of June 30, 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 June 30, 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 June 30, 2007.



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##### Table of Contents

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 June 30, 2007:



| |  |  | 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 June 30, 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 June 30, 2007. 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 half of 2007 but recognized losses for three of the five years ended December 31, 2006. As of June 30, 2007, our accumulated deficit was $21.6 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. For the three- and six- month periods ended June 30, 2007, software maintenance fees represented 44% and 42% of our total revenue, respectively. 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 68% and 67% of our total sales
for the three- and six- months ended June 30, 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



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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 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.



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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.

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 56% and 61% of our total revenues for the three- and six- month periods ended June 30, 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



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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.

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.



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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.

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.



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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 June 30, 2007, 501,300 shares had been repurchased at a cost of approximately $1,869,000. No shares were repurchased in
2007, 2006 or 2005. The following table provides information about purchases by the company during the quarter ended June 30, 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 per Share |   | 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)
|04/01/07-04/30/07 |  | 0                                                |  | $                           |  |                                                                                                          | 501,300 |                                                                                  | 148,700
|05/01/07-05/31/07 |  | 0                                                |  |                             |  |                                                                                                          | 501,300 |                                                                                  | 148,700
|06/01/07-06/30/07 |  | 0                                                |  |                             |  |                                                                                                          | 501,300 |                                                                                  | 148,700

---

|(1) | To date we have 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                                                                                                                                                                                          
|10.1          |  | Severance Benefits Agreement, dated June 7, 2007 between Gensym Corporation and Stephen D. Allison (Incorporated by reference to the Registrants current reported on Form 8-K filed on June
8, 2007)
|              | 
|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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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: August 8, 2007 |  |  |  | /s/ STEPHEN D. ALLISON                                              
|                      |  |  |  | Stephen D. Allison                                                  
|                      |  |  |  | Chief Financial Officer (Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|              |  |                                                                                                                                                                                                      
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                          
|10.1          |  | Severance Benefits Agreement, dated June 7, 2007 between Gensym Corporation and Stephen D. Allison (Incorporated by reference to the Registrants current reported on Form 8-K filed on June
8, 2007)
|              | 
|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.                                                   



32