<PAGE>   1

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

                                    FORM 10-Q


(Mark one)

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

                      FOR THREE MONTHS ENDED JUNE 30, 1997

                                       OR

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


                         COMMISSION FILE NUMBER: 0-27696


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


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


                             125 CAMBRIDGEPARK DRIVE
                               CAMBRIDGE, MA 02140
                    (Address of principal executive offices)

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




      Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:

                  Yes  [X]                                  No [ ]

      As of August 6, 1997 there were 6,336,112 shares of the Registrant's
Common Stock outstanding.



                                       1
<PAGE>   2

                               GENSYM CORPORATION
                                 Form 10-Q INDEX

                          PART I. FINANCIAL INFORMATION


                                                                        PAGE NO.
                                                                        --------
Item 1.     Condensed Consolidated Financial Statements:

            Condensed Consolidated Balance Sheets
            June 30, 1997 and December 31, 1996                               3

            Condensed Consolidated Statements of Operations
            Three and six months ended June 30, 1997 and 1996                 4

            Condensed Consolidated Statements of Cash Flows 
            Six months ended June 30, 1997 and 1996                           5

            Notes to Condensed Consolidated Financial Statements            6-7

Item 2.     Management's Discussion and Analysis of

            Financial Condition and Results of Operations                  8-17

Item 3.     Quantitative and Qualitative Disclosures 
            About Market Risk                                                17


                           PART II. OTHER INFORMATION

Item 1.     Legal Proceedings                                                18

Item 2.     Changes in Securities                                            18

Item 3.     Defaults Upon Senior Securities                                  18

Item 4.     Submission of Matters to a Vote of Security Holders              18

Item 5.     Other Information                                                19

Item 6.     Exhibits and Reports on Form 8-K                                 19

            Signatures                                                       20












                                       2
<PAGE>   3

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


                       GENSYM CORPORATION AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (UNAUDITED)

<TABLE>
<CAPTION>

(in thousands)                                 JUNE 30,      DECEMBER 31,
                                                 1997           1996
                                               -------       -----------
<S>                                            <C>            <C>    
                   ASSETS

Current Assets:
      Cash and cash equivalents                $ 9,587        $11,679
      Short-term investments                     6,202          7,911
      Accounts receivable, net                   8,616          9,736
      Prepaid expenses                           1,915          1,754
      Deferred income taxes                      1,579          1,579
                                               -------        -------
         Total current assets                   27,899         32,659
                                               -------        -------

Property and Equipment, net                      2,847          2,641

Long-term investments                            1,036            742
Deposits and other assets                          280            215
                                               -------        -------

                                               $32,062        $36,257
                                               =======        =======


    LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
      Accounts payable                         $ 1,244        $ 1,262
      Accrued expenses                           5,339          5,109
      Deferred revenue                           5,421          5,818
                                               -------        -------
         Total current liabilities              12,004         12,189
                                               -------        -------

Stockholders' Equity:
      Common stock                                  63             62
      Capital in excess of par value            19,558         18,727
      Retained earnings                            763          5,356
      Cumulative translation adjustment           (326)           (77)
                                               -------        -------
         Total stockholders' equity             20,058         24,068
                                               -------        -------

                                               $32,062        $36,257
                                               =======        =======
</TABLE>







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




                                       3
<PAGE>   4


                       GENSYM CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)


<TABLE>
<CAPTION>

(in thousands except per share amounts)

                                                THREE MONTHS ENDED        SIX MONTHS ENDED
                                                      JUNE 30,                 JUNE 30,
                                                 1997        1996          1997        1996
                                               -------      ------       -------      -------
<S>                                            <C>          <C>          <C>          <C>    
REVENUES:
    Product                                    $ 3,337      $5,649       $ 9,269      $10,372
    Service                                      4,538       3,852         8,637        7,570
                                               -------      ------       -------      -------
      Total revenues                             7,875       9,501        17,906       17,942
                                               -------      ------       -------      -------

COST OF REVENUES                                 2,409       1,811         4,740        3,457
                                               -------      ------       -------      -------

      Gross profit                               5,466       7,690        13,166       14,485
                                               -------      ------       -------      -------

OPERATING EXPENSES:
    Sales and marketing                          5,038       4,344         9,749        8,558
    Research and development                     1,902       1,462         3,769        2,858
    General and administrative                   1,293         920         2,293        1,653
    Restructuring charge                         2,042           0         2,042            0
                                               -------      ------       -------      -------
                                                10,275       6,726        17,853       13,069
                                               -------      ------       -------      -------

      Operating income (loss)                   (4,809)        964        (4,687)       1,416

OTHER INCOME, NET                                  150         153           134          217
                                               -------      ------       -------      -------

      Income (loss) before
        provision for income taxes              (4,659)      1,117        (4,553)       1,633

PROVISION FOR INCOME TAXES                          --         414            40          596
                                               -------      ------       -------      -------

      Net income (loss)                        $(4,659)     $  703       $(4,593)     $ 1,037
                                               =======      ======       =======      =======

      Net income (loss) per share              $ (0.74)     $ 0.11       $ (0.73)     $  0.17
                                               =======      ======       =======      =======
      Weighted average common and common
        equivalent shares outstanding            6,302       6,496         6,262        6,117
                                               =======      ======       =======      =======
</TABLE>




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



                                       4
<PAGE>   5


                       GENSYM CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
(in thousands)                                               SIX MONTHS   ENDED  
                                                                  JUNE 30,   
                                                            1997           1996
                                                           -------        -------
<S>                                                        <C>            <C>    

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                        $(4,593)       $ 1,037
  Adjustments to reconcile net income to net cash
     provided by (used in) operating activities:
     Depreciation                                              574            540
     Deferred taxes                                             --              3
     Restructuring charge                                    2,019             --
     Changes in assets and liabilities:
        Accounts receivable                                  1,079           (757)
        Prepaid expenses                                      (652)          (439)
        Accounts payable                                         8           (199)
        Accrued expenses                                    (1,310)           823
        Deferred revenue                                      (390)           322
                                                           -------        -------
           Net cash provided by (used in)
           operating activities                             (3,265)         1,330
                                                           -------        -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  (Purchases) sales of short-term investments                1,709         (1,414)
  Purchases of long-term investments                          (294)            --
  Purchases of property and equipment                         (779)          (410)
  (Increase) decrease in other assets                          (75)            51
                                                           -------        -------
           Net cash provided by (used in)
           investing activities                                561         (1,773)
                                                           -------        -------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from exercise of stock under stock plans            832            254
  Proceeds from initial public offering - net                   --         11,953
                                                           -------        -------

           Net cash provided by financing activities           832         12,207

EFFECT OF EXCHANGE RATE CHANGES ON CASH                       (220)           (54)
                                                           -------        -------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS        (2,092)        11,710

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD              11,679          2,126
                                                           -------        -------

CASH AND CASH EQUIVALENTS, END OF PERIOD                   $ 9,587        $13,836
                                                           =======        =======
</TABLE>





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



                                       5
<PAGE>   6
                       GENSYM CORPORATION AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 (UNAUDITED)


1.   Operations

Gensym Corporation (the "Company") is a leading supplier of software products
and services for developing and deploying intelligent solutions in a broad range
of industrial, scientific, commercial and government markets.

2.   Basis of Presentation

The unaudited condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been condensed or omitted
pursuant to such SEC rules and regulations; nevertheless, the management of the
Company believes that the disclosures herein are adequate to make the
information presented not misleading. In the opinion of management, the
condensed consolidated financial statements reflect all adjustments (of a normal
and recurring nature) which are necessary to present fairly the consolidated
financial position of the Company as of June 30, 1997 and the results of its
operations for the three and six month periods ended June 30, 1997 and 1996 and
its cash flows for the six months then ended. These condensed consolidated
financial statements and notes thereto should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K filed with the SEC on March 31, 1997. The results of
operations for the interim period are not necessarily indicative of the results
of operations for the full year.

3.   Joint Venture

In October 1996, the Company entered into a joint venture, PDS Technologies LLC
("PDS"), in which it holds a 50% interest. The Company is accounting for this
joint venture using the equity method and has recorded its share of the loss
from the joint venture in other income. Since October 1996, the Company invested
a total of $800,000 in PDS and is not obligated to further fund the joint
venture.

4.   Investments

The Company applies Statement of Financial Accounting Standards ("SFAS") No.
115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, the Company's investments are classified as available-for-sale and
are recorded at fair value, which approximates amortized cost at June 30, 1997
and December 31, 1996. Cash equivalents are short-term, highly liquid
investments with original maturity dates of less than three months. Short-term
investments held as of June 30, 1997 and December 31, 1996 consist of municipal
bonds with original maturity dates greater than three months and less than one
year. Long-term investments held as of June 30, 1997 and December 31, 1996,
consist of municipal bonds with original maturity dates of greater than one
year.





                                       6
<PAGE>   7

5.   Restructuring Charge

In June, 1997, the Company formalized a plan of restructuring intended to lower 
operating expenses by reducing its workforce by 15% and closing and
consolidating several sales offices, as well as consolidating office space in
its corporate headquarters. Accordingly, the Company has recorded a
restructuring charge of approximately $2.0 million in the quarter ended June
30, 1997. This amount includes $850,000 for estimated rent and lease
termination costs for consolidating facilities and equipment, $725,000 for
severance and other employee termination costs, and $425,000 for the write-off
of certain assets that will provide no future benefit to the Company as a
result of the restructuring plan. The Company anticipates the restructuring
efforts to be completed in the next twelve months. As of June 30, 1997,
approximately $400,000 of restructuring costs have been incurred and charged
against the restructuring liability.

6.   Significant Accounting Policies

In March 1997, the Financial Accounting Standards Board issued SFAS No. 128,
Earnings Per Share. SFAS No. 128 establishes standards for computing and
presenting earnings per share and applies to entities with publicly held common
stock or potential common stock. This statement is effective for fiscal years
ending after December 15, 1997 and early adoption is not permitted. When
adopted, the statement will require restatement of prior years' earnings per
share. The Company will adopt this statement for its fiscal year ended December
31, 1997. In addition, the Company believes that the adoption of SFAS No. 128
will not have a material effect on its reported earnings per share.

7.   Stockholders' Equity and Per Share Data

For the three and six months ended June 30, 1996, net income per common and
common equivalent share was computed using the weighted average number of common
and common equivalent shares outstanding during the period in accordance with
the treasury stock method. For the three and six months ended June 30, 1997, net
loss per common and common equivalent share was computed using the weighted
average number of common shares outstanding and excludes shares issuable from
assumed exercise of options as their effect would be antidilutive.




                                       7
<PAGE>   8

Item 2.              MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

    The Company was incorporated in 1986 to provide software products for
developing and deploying intelligent systems for decision support and control.
The Company released the first version of G2, its core product, in May 1988, and
since that time has introduced enhanced versions of G2 and has expanded its
product line to include several G2-based application products as well as several
G2 connectivity products. In addition, the Company derives significant service
revenues from maintenance contracts, consulting services, and training courses
related to its software products.

     The Company markets and sells products through its direct sales force in
the United States, Europe, Africa, and Asia, as well as through selected
distributors in other countries, including Japan. The Company also sells its
products through a network of value-added resellers and systems integrators who
provide consulting services and integrated solutions to their customers. The
Company believes that there is a trend among end-users in its markets toward
purchasing complete solutions, rather than software tools with which to develop
such solutions. This trend has increased the Company's reliance on such
value-added resellers and systems integrators to provide consulting services and
integrated solutions to end-users, and has led the Company to increase its own
capabilities to deliver complete solutions directly. In January 1997, the
Company established three strategic business units, Manufacturing,
Communications, and Advanced Systems, to manage domain-specific expertise,
products, and services required to serve mainstream customers. The Company has
also adopted a solutions-oriented approach in its sales, marketing, product
development and service organizations.

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




                                       8
<PAGE>   9


RESULTS OF OPERATIONS

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


<TABLE>
<CAPTION>
                                           THREE MONTHS ENDED       SIX MONTHS ENDED
                                                 JUNE 30,                JUNE 30,
                                            1997        1996         1997        1996
                                           -----       -----        -----       ----- 
<S>                                         <C>         <C>          <C>         <C>  

REVENUES:
     Product                                42.4%       59.5%        51.8%       57.8%
     Service                                57.6%       40.5%        48.2%       42.2%
                                           -----       -----        -----       ----- 
        Total revenues                     100.0%      100.0%       100.0%      100.0%
                                           -----       -----        -----       ----- 

COST OF REVENUES:                           30.6%       19.1%        26.5%       19.3%
                                           -----       -----        -----       ----- 

        Gross profit                        69.4%       80.9%        73.5%       80.7%
                                           -----       -----        -----       ----- 

OPERATING EXPENSES:
     Sales and marketing                    64.0%       45.7%        54.4%       47.7%
     Research and development               24.2%       15.4%        21.0%       15.9%
     General and administrative             16.4%        9.7%        12.8%        9.2%
     Restructuring charge                   25.9%        0.0%        11.4%        0.0%
                                           -----       -----        -----       ----- 
                                           130.5%       70.8%        99.7%       72.8%
                                           -----       -----        -----       ----- 

        Operating income (loss)            (61.1%)      10.2%       (26.2%)       7.9%
                                           -----       -----        -----       ----- 

OTHER INCOME, NET                            1.9%        1.6%         0.7%        1.2%
                                           -----       -----        -----       ----- 
        Income (loss) before
        provision for income taxes         (59.2%)      11.8%       (25.4%)       9.1%

PROVISION FOR INCOME TAXES                   0.0%        4.4%         0.2%        3.3%
                                           -----       -----        -----       ----- 

        Net income (loss)                  (59.2%)       7.4%       (25.6%)       5.8%
                                           =====       =====        =====       ===== 
</TABLE>




                                       9
<PAGE>   10

THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996

Revenues

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

     Total revenues were $7.9 million for the quarter ended June 30, 1997 as
compared to $9.5 million for the same period in 1996, a decrease of 17.1%. The
decrease in total revenues was attributable to decreased sales of product
licenses, partially offset by an increase in services. For the six month periods
ended June 30, 1997 and 1996, total revenues remained constant at $17.9 million,
with decreased sales of product licenses offset by an equal increase in
services. International revenues accounted for 43.6% and 44.0% of total revenues
in the second quarter of 1997 and 1996, respectively, and 46.3% and 45.5% of
total revenues for the first six months of 1997 and 1996, respectively. Within
the international geographies, increases in revenues from the Europe/Middle
East/Africa regions substantially offset decreases in revenues from the
Asia/Pacific regions.

     Product. Product revenues decreased to $3.3 million in the second quarter
of 1997 from $5.6 million in the second quarter of 1996, a decrease of 40.9%.
For the six month period ended June 30, 1997 product revenues decreased to $9.3
million from $10.4 million in the same period in 1996, a decrease of 10.6%. The
decrease in product revenues reflected lower bookings in the second quarter,
most notably in the United States and Asia/Pacific, which the Company believes
was primarily due to the continued effects of a strategic reorganization and
retraining of the Company's sales force and a longer sales cycle caused by the
Company's shift to selling complete solutions. While the Company does not have a
material amount of backlog at any given time, the backlog at June 30, 1997
decreased from the backlog at December 31, 1996.

     Service. Service revenues increased to $4.5 million in the second quarter
of 1997 from $3.9 million in the second quarter of 1996, an increase of 17.8%.
For the six month period ended June 30, 1997 service revenues increased to $8.6
million from $7.6 million in the same period in 1996, an increase of 14.1%. The
increase in service revenues was primarily due to increased maintenance fees
derived from an increased customer base. The remaining increase in service
revenues was attributable to an increase in application consulting. The Company
has continued to expand its application consulting organization to meet the
growing demand from customers and partners for solution-level applications and
implementation support.

  Cost of Revenues

    Cost of revenues primarily consists of consulting labor, technical support
costs and the costs of material and labor involved in producing and distributing
the Company's software. These costs increased to $2.4 million in the second
quarter of 1997 from $1.8 million in the second quarter of 1996, an increase of
33.1%. For the six month period ended June 30, 1997 cost of revenues increased
to $4.7 million from $3.5 million in the same period in 1996, an increase of
37.1%. Cost of revenues increased due to the increase in service revenues and
consisted primarily of increases in consulting labor costs. Gross margin on
revenues decreased to 69.4% for the second quarter of 1997 from 80.9% for the
second quarter of 1996. For the first six months of 1997, gross margin on
revenues decreased to 73.5% from 80.7% in the same period in 1996. This decrease
in gross margin reflected a higher percentage of lower margin service revenues
as a percentage of total revenues, an increase in consulting personnel,
including outside contractors and an increase in technical support personnel.
The Company anticipates that the mix between product and service revenues will
return closer to 1996 levels as anticipated product revenue increases, and that
overall margins will increase.




                                       10
<PAGE>   11

Operating Expenses

     Sales and Marketing. Sales and marketing expenses consist primarily of
costs associated with personnel involved in the sales and marketing process,
sales commissions, sales facilities, travel and living, trade shows and
seminars, advertising and promotional materials. These expenses increased to
$5.0 million (64.0% of revenues) in the second quarter of 1997 from $4.3 million
(45.7% of revenues) in the second quarter of 1996, an increase of 16.0%. For the
six month period ended June 30, 1997, these expenses were $9.7 million (54.4% of
revenues) and $8.6 million (47.7% of revenue) in the same period in 1996. The
increase in absolute dollars was primarily due to the opening of new sales
offices in the United States and in Asia/Pacific as well as to continued
investment in the Company's global sales and marketing capabilities, including
the addition of senior level management positions to manage three newly
established strategic business units. This increase was also due, to a lesser
extent, to increased costs related to adopting a solutions-oriented approach in
the sales and marketing organization, including the cost of solution selling
training programs provided to the sales force. The increase as a percentage of
total revenues was primarily due to the lower product revenues reported for the
periods. While the Company plans to hire more direct sales personnel in the
coming quarters, the Company expects sales and marketing expenses to decrease as
a percentage of total revenues due to the reduction already taken of certain
sales and marketing administrative personnel, the consolidation of sales offices
and other measures taken as part of the second quarter restructuring plan.

     Research and Development. Research and development expenses consist
primarily of costs of personnel, equipment, and facilities. These expenses
increased to $1.9 million (24.2% of revenues) in the second quarter of 1997 from
$1.5 million (15.4% of revenues) in the second quarter of 1996, an increase of
30.1%. For the six month period ended June 30, 1997, these expenses were $3.8
million (21.0% of revenues) and were $2.9 million (15.9% of revenue) in the same
period in 1996, an increase of 31.8%. The increase in absolute dollars was
primarily due to an increase through the second half of 1996 and the first half
of 1997 in engineering personnel devoted to enhancements, new features, and
quality assurance for the G2 product family, as well as to the development of
new products, which resulted in several major commercial releases in the second
quarter. The increase as a percentage of total revenues was primarily due to the
lower product revenues reported for the periods. The Company plans to control
hiring and overall research and development expenses relative to anticipated
future revenues over coming quarters and expects that they will decrease as a
percentage of total revenues.

     General and Administrative. General and administrative expenses consist
primarily of personnel costs for finance, administration, operations, and
general management, as well as legal and accounting expenses. These expenses
increased to $1.3 million (16.4% of revenues) in the second quarter of 1997 from
$920,000 (9.7% of revenues) in the second quarter of 1996, an increase of 40.4%.
For the six month period ended June 30, 1997, these expenses increased to $2.3
million (12.8% of revenues) from $1.7 million (9.2% of revenue) in the same
period in 1996, an increase of 38.8%. The increase in absolute dollars was
primarily due to an increase in the number of personnel in the Company's
information systems departments to strengthen the Company's infrastructure, as
well as to amortization of the newly implemented financial information system
and costs related to being a public company, such as proxy statement preparation
and shareholders' meeting expenses. The increase as a percentage of total
revenues was due to the above factors as well as to the lower product revenues
reported for the periods. The Company expects that these expenses will decline
as a percentage of total revenues primarily due to the reduction already taken
in administrative personnel, the consolidation of facilities and other actions
taken as part of the second quarter restructuring plan.




                                       11
<PAGE>   12

     Restructuring. During the first quarter of 1997, the Company underwent a
major reorganization and adopted a solutions-oriented approach in the sales,
marketing and service organizations to better meet the buying requirements of
companies in its primary target markets. This approach required a strategic
reorganization and retraining of the sales force, and a major change in sales
account structure. The Company also established dedicated business units in
order to further develop and coordinate domain-specific expertise, products and
services for its customers. The transition to and emphasis on selling solutions
rather than tools extended the Company's sales cycle and resulted in lower
license bookings, especially in the United States. This impact extended into the
second quarter, during which the Company was unable to sustain profitable
operations at the existing resource levels. In response to these circumstances,
management decided on a course of action that was intended to lower operating
expenses by rightsizing staff and consolidating facilities to levels more
appropriate to the present sales capacity and business requirements. The
decision resulted in a planned 15% reduction in the Company's workforce, with a
bias toward administrative positions, though all functional areas were affected
to some degree. The decision also resulted in the planned closing and
consolidation of several sales offices, as well as office space consolidation in
the corporate headquarters.

   As a direct result of management's plans, the Company recognized $850,000 for
estimated rent and lease termination costs for consolidating facilities and
equipment, including the write-off of certain leasehold improvements and excess
equipment. The Company also recognized $725,000 for severance and other employee
termination costs that related to the workforce reduction and $425,000 for the
write-off of certain assets that will provide no future benefit to the Company
as a result of the restructuring plan.

   At June 30, 1997, the Company had taken certain actions consistent with the
restructuring plan, predominantly related to headcount reduction. As of June 30,
1997, approximately $400,000 of restructuring costs had been incurred and
charged against the restructuring liability. As a result of the restructuring
plan, the Company expects to reduce certain future costs including payroll and
payroll related costs, building rent and leased equipment by approximately $1
million per quarter. The Company anticipates realizing a significant amount of
these savings beginning in the third quarter, with the facilities impact
beginning in the following two quarters.

  Other Income

   Other income consists primarily of interest income offset by foreign exchange
transaction gains and losses and by Gensym's 50 percent share in the net loss of
its joint venture investment in PDS. Other income decreased to $134,000 in the
first six months of 1997 from $216,000 in the same period in 1996. The decrease
was primarily due to the Company's share of the net loss in PDS recorded in
1997, partially offset by an increase in interest income. The increase in
interest income was primarily due to increased balances in cash, cash
equivalents and short and long-term investments, primarily as a result of
proceeds from the Company's initial public offering in February 1996.

  Income Taxes

   The Company generated a significant tax loss carryforward during the six
months ended June 30, 1997. Under SFAS No. 109, the Company cannot recognize a
deferred tax asset for the future benefit of its tax loss carryforward unless it
concludes that it is "more likely than not" that such deferred tax asset would
be realized. Accordingly, the Company has established a valuation allowance
against its deferred tax asset to the extent that it believes it is "more likely
than not" these assets will not be realized. In determining the amount of
valuation allowance required, the Company considers numerous factors, including
historical profitability, estimated future taxable income and the volatility of
its historical earnings and of the industry in which it operates. The Company's
effective tax rate for the second quarter of 1997 was 0% as compared to 36.5%
for the second quarter of 1996.





                                       12
<PAGE>   13

LIQUIDITY AND CAPITAL RESOURCES

   The Company currently finances its operations (including capital
expenditures) primarily through cash flow from operations and its current cash
and short-term investments balances. In addition, the Company has $5.0 million
of equipment financed under long-term operating leases. The Company's operating
lease commitments consist primarily of operating leases for the Company's
facilities and computers. The Company used cash in operating activities of $3.3
million during the first six months of 1997. Cash used in operations in the
first six months of 1997 was primarily due to the net loss, an increase in
prepaid expenses and decreases in accrued expenses and deferred revenue, offset
by the restructuring charge and a decrease in accounts receivable.

   At June 30, 1997, the Company had cash, cash equivalents, and short-term
investments of $15.8 million. The Company regularly invests excess funds in
short-term, highly rated money market funds, government securities, and
commercial paper. In addition, the Company had long-term investments of $1.0
million, primarily consisting of municipal bonds with original maturity dates of
greater than one year.

    At June 30, 1997, the Company expected that cash requirements to settle its
restructuring obligations would be approximately $1.3 million. These cash
requirements pertain primarily to severance and lease termination costs and are
expected to be fulfilled within the next twelve months. The Company believes
that the settlement of its restructuring obligations will not materially impact
future liquidity.

   In the second quarter, the Company renewed its bank line of credit on
substantially similar terms as previously arranged. At June 30, 1997, the
Company had the availability to borrow up to $1.0 million at an interest rate of
prime. This bank line of credit will expire on May 31, 1998 and requires the
Company to maintain certain financial covenants. The Company was in compliance
with all covenants contained in the bank line of credit at June 30, 1997 and
during the first six months of 1997. There were no borrowings under the bank
line of credit for the period ended June 30, 1997.

   Investing activities provided $561,000 during the first six months of 1997
and utilized $1.8 million during the first six months of 1996. During the first
six months of 1997 the sale of short-term investments provided $1.7 million,
which was offset primarily by the purchase of property and equipment ($779,000)
and the purchase of long-term investments ($294,000). The principal uses in the
first six months of 1996 were to fund the purchase of $1.4 million of short-term
investments and $410,000 of property and equipment. The Company expects that its
requirements for computers, office facilities, and office equipment will
fluctuate as staffing requirements dictate and that such equipment and
facilities will be available when needed.

   The Company believes that the currently available funds and cash generated
from operations will be sufficient to meet the Company's business requirements
at least through June 30, 1998.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

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

    Emerging Market for Intelligent Systems. Substantially all of the Company's
revenues are derived from the licensing and support of software products that
enable organizations to implement intelligent systems for decision support and
control applications. Although many organizations have begun to deploy, or have
announced plans to deploy, intelligent systems, these systems are different from
the basic monitoring and control systems that are traditionally employed by
these organizations. There can be no assurance that these organizations will be
able to introduce intelligent systems successfully nor that such systems will
gain widespread acceptance. In addition, the timing of the implementation of
intelligent systems by organizations may be affected by economic factors,
government regulations, and other factors. Delays in the introduction of
intelligent systems or the failure of these systems to 




                                       13

<PAGE>   14

gain widespread market acceptance would materially and adversely affect the
Company's business, results of operations, or financial condition. In addition,
the Company believes that end-users in its market are increasingly seeking
complete solutions, rather than software tools with which to develop such
solutions. Meeting this demand has required the Company to modify its sales
approach and increase its capabilities to deliver complete solutions. The
Company is also increasingly reliant on value-added resellers and systems
integrators to deliver services to implement these solutions. The modified sales
approach may also lengthen the Company's average sales cycle. Failure by the
Company to respond appropriately to such a shift in market demand could have a
material adverse effect on the Company's business, results of operations, or
financial condition.

     Variability of Quarterly Operating Results. The Company has experienced,
and may experience in the future, significant quarter-to-quarter fluctuations in
its operating results. The Company has, on occasion, recorded quarterly
losses, and there can be no assurance that revenue growth or profitable
operations can be attained on a quarterly or annual basis in the future. The
Company's sales cycle typically ranges from six to 12 months, and the cost of
acquiring the Company's software, building and deploying applications, and
training users represents a significant expenditure for customers. The Company's
relatively long sales cycle and high license fees, together with fixed
short-term expenses, can cause significant variations in operating results from
quarter to quarter, based on a relatively small variation in the timing of major
orders. Factors such as the timing of new product introductions and upgrades,
the timing of significant orders, the mix of products sold, and the mix of
domestic versus international revenues could contribute to this quarterly
variability. For example, the Company has experienced in the past, and may
experience in the future, delays in customer maintenance renewals due to
unforeseen delays in product releases. In addition, the Company's expense levels
are based in part on expectations of future revenue levels. A shortfall in
expected revenues could therefore result in a disproportionate decrease in the
Company's net income. The Company's financial performance has generally been
somewhat weaker in the first quarter than in the other fiscal quarters, due to
customer purchasing patterns.

     Economic Factors. Because capital expenditures are often viewed as
discretionary by organizations, sales of the Company's products for capital
budget projects are subject to general economic conditions. Such capital
expenditures are also susceptible to industry-specific economic downturns.
Certain industries have experienced weakened demand in the past, which has
adversely affected the Company's revenues, gross margin, and operating results
during such periods. There can be no assurance that future recessionary
conditions in the markets for the Company's products will not adversely affect
the Company's business, results of operations, or financial condition.

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

     New Products and Rapid Technological Change. The market for the Company's
products is relatively new and is characterized by rapid technological change,
evolving industry standards, 




                                       14
<PAGE>   15


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

     Reliance Upon Indirect Distribution Channels. The Company sells its
products in part through value-added resellers, systems integrators, and
distributors, none of which is under the control of the Company. Sales of the
Company's products by value-added resellers and systems integrators represented
26%, 28% and 38% of the Company's product revenues in 1995, 1996 and the first
six months of 1997, respectively. Sales of the Company's products by
distributors, primarily the Company's Japanese distributor, accounted for 14%,
14% and 9% of the Company's product revenues in 1995, 1996 and the first six
months of 1997, respectively. The loss of one or more major third-party
distributors or resellers of the Company's products, a significant decline in
their sales, or difficulty on the part of such third-party developers or
resellers in developing successful G2-based products and applications, could
have a material adverse effect on the Company's business, results of operations,
or financial condition. There can be no assurance that the Company will be able
to attract or retain additional qualified third-party resellers or that
third-party resellers will be able to effectively sell and implement the
Company's products. In addition, the Company relies on third-party resellers to
provide post-sales service and support to its customers, and any deficiencies in
such service and support could adversely affect the Company's business, results
of operations, or financial condition.

     Risks Associated With International Operations. The Company's international
revenues represented 44%, 42% and 46% of total revenues in 1995, 1996, and the
first six months of 1997, respectively. Revenues are categorized by the Company
according to product shipment destination and therefore do not necessarily
reflect the ultimate country of installation. The international portion of the
Company's business is subject to a number of inherent risks, including
difficulties in building and managing international operations, difficulties in
localizing products and translating documentation into local languages,
fluctuations in the value of international currencies, fluctuating import/export
duties and quotas, and unexpected regulatory, economic, or political changes in
international markets. There can be no assurance that these factors will not
adversely affect the Company's business, results of operations, or financial
condition.

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

     Competition. Although the Company believes that there are no other
commercially available products that offer the full range of high-level
capabilities embodied in the Company's products or 



                                       15
<PAGE>   16

compete across all of the markets that the Company addresses, a number of
companies offer point solution products that perform certain functions of the
Company's products. Moreover, new competitors could enter the intelligent
systems market, and existing competitors could expand the capabilities of their
products to equal or exceed those of the Company's products. In addition, there
are commercially available software development tools that software application
developers or potential customers could use to build software having
functionality similar to the Company's products.

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

     The Company's products can also be used to perform lower-level functions
such as monitoring, supervisory control, cell control, and other similar
functions that do not utilize all of G2's capabilities. For these functions, G2
competes with products offered by a number of other companies. The Company
believes that its products compete favorably in these functional areas where
breadth of applicability, flexibility, maintainability, scalability, and ease of
use are important considerations. However, certain competitors in this category
have greater financial and other resources than the Company and might introduce
new or improved products to compete with G2, possibly at lower prices.

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

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

     Management of Growth. The Company's business has grown significantly over
the past several years. This growth has resulted in an increase in
responsibilities placed upon the Company's management and has placed added
pressures on the Company's operating and financial systems. For example, the
Company's expansion of its international operations introduced significant
legal, tax, and accounting complexities, as well as the challenges associated
with managing geographically dispersed operations. To manage its growth
effectively, the Company will be required to implement additional management and
financial systems and controls, and to expand, train, and manage its employee
base. There can be no assurance that the management and systems currently in
place will be adequate if the Company continues to grow, or that the Company
will be able to implement additional systems successfully and in a timely manner
as required. Any future strategic transactions such as acquisitions or equity
investments would place additional strains upon the Company's 



                                       16
<PAGE>   17

management resources. There can be no assurance that the Company will be
effective in managing its future growth or that any failure to manage growth
will not have a material adverse effect on the Company's business, results of
operations, or financial condition.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

      Not Applicable




                                       17
<PAGE>   18

PART II - OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

         None

ITEM 2.  CHANGES IN SECURITIES

         None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None

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

On May 21, 1997 the Company held its Annual Meeting of the Stockholders. The
following matters were adopted by the vote specified below:

<TABLE>
<CAPTION>
                                                            Authority
    Proposal                  Class Of Stock      For       Withheld
    --------                  --------------      ---       --------
                          
<C>                            <C>             <C>          <C>        <C>      <C>      
1)  Approval of election
    of two Class I
    Directors to the Board 
    of Directors for the 
    ensuing three years

    John A. Shane             Common Stock     5,395,327    237,069
    Thomas E. Swithenbank     Common Stock     5,395,627    236,769

                                                                                 Broker
    Proposal                  Class Of Stock      For       Against   Abstain   Non-votes
    --------                  --------------      ---       -------   -------   ---------
                         
2)  Adoption of the 1997      Common Stock     3,302,547    371,346    17,003   1,941,500
    Stock Incentive Plan

3)  Adoption of amendment     Common Stock     5,051,426    287,286    24,528     269,156
    to the 1995 Director 
    Stock Option Plan to 
    increase the annual 
    stock option grant 
    from 2,000 to 3,000 
    shares

4)  Approval of appointment   Common Stock     5,436,027      2,916   193,453          --
    by the Board of
    Directors of Arthur 
    Andersen LLP as 
    independent auditors
    for the current year

</TABLE>





                                       18
<PAGE>   19

ITEM 5.  OTHER INFORMATION

         None

ITEM 6.  EXHIBITS AND REPORTS OF FORM 8-K

         (a) Exhibit Index
             Exhibit 10.1 - Amendment to Business Loan Agreement dated May 31, 
               1997 between Gensym Corporation and State Street Bank and Trust 
               Company
             Exhibit 10.2 - 1997 Stock Incentive Plan 
             Exhibit 10.3 - 1995 Director Stock Option Plan, as amended 
             Exhibit 11 - Computation of Net Income Per Share 
             Exhibit 27 - Financial Data Schedule

         (b) A Current Report on Form 8-K dated April 8, 1997 was filed by
               Gensym on April 17, 1997.







                                       19
<PAGE>   20

                                   SIGNATURES


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



                                          GENSYM CORPORATION
                                          (Registrant)



                                          /s/ Lowell B. Hawkinson
                                          ------------------------------------- 
     Dated: August 12, 1997               Lowell B. Hawkinson
                                          Chief Executive Officer
                                          (Principal Executive Officer)


                                          /s/ Richard M. Darer
                                          -------------------------------------
     Dated: August 12, 1997               Richard M. Darer
                                          Vice President of Finance and
                                          Administration, and Chief Financial
                                          Officer
                                          (Principal Financial and Accounting
                                          Officer)





                                       20