UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

Commission file number 000-26679

Art Technology Group, Inc.

(Exact name of registrant as specified in its charter)

(617) 386-1000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value with Associated Preferred Stock Purchase Rights

(Title of Class)

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes o          No þ

      Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.     Yes o          No þ

      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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

      Indicate by check mark 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.

Large accelerated filer o          Accelerated filer þ          Non-accelerated filer o

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

      As of June 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $115,023,000.

Documents Incorporated by Reference

      Portions of the registrant’s proxy statement for its annual meeting of stockholders to be held on May 23, 2006 are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III.

ART TECHNOLOGY GROUP, INC.

INDEX TO FORM 10-K

      References in this report to “we”, “us”, “our” and “ATG” refer to Art Technology Group, Inc. and its subsidiaries. ATG and Art Technology Group are our registered trademarks, and ATG Wisdom is our trademark. This report also includes trademarks and trade names of other companies.

PART I

      Certain of the information contained in this annual report on Form 10-K consists of “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management based on information currently available to our management. Use of words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “should,” “likely” or similar expressions, indicate a forward-looking statement. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, those set forth below under the heading “Risk Factors.” We assume no obligation to update any forward-looking statements.

Our Business

      We develop and market an integrated suite of Internet commerce, service and marketing solutions, as well as related services, including support and maintenance, education, application hosting and professional services.

      We deliver software solutions to help consumer-facing organizations create an interactive experience for their customers and partners via the Internet and other channels. Our software helps our clients market, sell goods and services and provide self-service opportunities to their customers and partners, which can enhance clients’ revenues, reduce their costs and improve their customers’ satisfaction.

Corporate Information

      We were incorporated in 1991 in the State of Delaware and have been a publicly traded corporation since 1999. Our corporate headquarters are at 25 First Street, Cambridge, Massachusetts 02141. We have offices in Chicago, New York, Washington D.C., Seattle, the United Kingdom, France and Northern Ireland. As of December 31, 2005, we had a total of 309 employees and we had licensed our products to more than 600 customers. Our Internet web site address is www.atg.com.

      From 2001 through 2004, our annual revenue declined and we incurred significant losses and negative cash flow from operations. In 2005, our total revenues grew by 31% from 2004 and we achieved profitability and positive free cash flow.

Overview

      Our software solutions help organizations market to, sell to and service their customers and partners, via the Web, email, contact centers and mobile devices. Our solutions can enhance our clients’ revenues, reduce their costs and improve their customers’ satisfaction. We also offer software solutions that enable companies to deliver a superior customer experience via contact centers, information technology help desks, Web (intranet and Internet) self-service and electronic communication channels. Businesses and government organizations can use our solutions to provide a more productive and satisfying experience to their customers. We seek to differentiate ourselves by designing applications that enable our customers to provide their customers a more consistent and more relevant experience across the various touch points of Web, email, contact centers and across the lifecycle of marketing, commerce and service. Our software delivers better consistency and relevancy by capturing and maintaining information about those customers’ personal preferences, online activity, and transaction and service history, and by using this information to deliver more personalized and contextual content to such users.

      We traditionally have marketed our products and services to Global 2000 companies, government organizations, and other businesses that have large numbers of online users and utilize the Internet as a primary business channel. In the past, we have focused on providing our software and services to businesses in financial services, retail, media and entertainment, telecommunications, manufacturing, high-tech, consumer products and services industries. Our customers include Best Buy, Office Max, Kingfisher, Neiman Marcus, Target, Friends Provident, Merrill Lynch, Wells Fargo, HSBC, A&E Networks, Warner Music, Cingular,

France Telecom, Philips, Procter & Gamble, Hewlett-Packard, American Airlines, InterContinental Hotels Group, US Army, and US Federal Aviation Administration.

      Our business has evolved significantly since our incorporation in 1991:

Our Strategy

      Our objective is to be the industry leader in providing a comprehensive customer-facing software platform for companies striving to give their customers a more consistent and relevant online experience and grow their e-commerce and e-services presence. We intend to achieve this objective by implementing the following key components of our strategy:

Products

      We provide a suite of powerful and dynamic software solutions designed to enable companies to deploy commerce, marketing, and service solutions. Our software is also designed to provide content administrators and marketing executives with greater flexibility in maintaining their website content and in optimizing their consumers’ experience to improve revenue and cost performance.

      We offer application products in three functional areas: ATG Commerce, ATG Service, and ATG Marketing.

      Our online commerce applications are designed for the development of large consumer-facing e-commerce sites and channel partner extranets, and are used by our clients to facilitate transactions with consumers and channel partners. We believe that, by using our online sales and marketing solutions together, our clients can create sophisticated promotions and offers that can drive incremental sales. We offer the following ATG Commerce solutions:

      Our customer service applications are designed to decrease call-center and help-desk service costs, to improve the speed with which customer needs are met, and to increase customer loyalty and satisfaction. We believe our self-service solutions become more useful through the use of our advanced personalization capabilities. These personalization capabilities increase the likelihood that customer inquiries will be managed online, avoiding the need for costly contact center inquiry, and also help contact center personnel respond more quickly and accurately to inquiries which are handled by them. We offer the following ATG Service solutions:

      Our marketing applications are designed to help businesses attract new customers, promote new offerings to existing customers, and improve the cost-effectiveness of existing marketing expenditures. Our clients use our software to maintain personalized, relevant email contact with their customers, and to integrate their online marketing activities with related sales and customer service initiatives. We strive to differentiate ourselves from our competitors by providing better integration among email, Web and contact center marketing activities, and by enabling more personalized and relevant campaigns. Our products are designed to allow businesses to increase marketing effectiveness by visually defining desired customer experience activities and events that will drive desirable customer behavior. We offer the following ATG Marketing products:

      Our products allow companies to present a single view of themselves to their customers through our repository integration. This integration technology allows companies to easily access and utilize data in the enterprise regardless of the data storage format or location. The data can be leveraged in native form without having to move, duplicate or convert the data. By enabling these capabilities in a cost-effective manner, we believe our products can help companies protect their brands and keep their customers from becoming confused or frustrated, all of which positively impact customer satisfaction and loyalty.

      Our Adaptive Scenario Engine (ASE) capability is designed to help our clients make each interaction with their customers more productive and effective. These personalization capabilities help ensure that consumers are presented with the most relevant information. By avoiding information overload, consumers are more likely to have their needs met through the low cost online channel — increasing the speed at which customer needs are met and decreasing the likelihood the consumer will use a more expensive channel such as a call center. ASE capabilities can also make interactions with consumers more effective for our clients. It allows a business user to visually design a sequence of behaviors that our client would like to encourage a consumer to undertake — which can lead to a specific goal such as a site registration or transaction. Our capabilities automatically monitor and encourage consumers to follow these pre-defined behavior patterns, enabling our customer to maximize the effectiveness of each interaction with the consumer.

      We support the adoption of open application server infrastructure by our existing and new clients and plan to work closely with other platform vendors to increase the value customers receive from our products regardless of the platform they select.

Services

      Our services organization provides a variety of consulting, design, application development, deployment, integration, hosting, training and support services in conjunction with our products. These services are provided through our customer support, professional services, application hosting, and education groups.

      Customer Support Services. We offer five levels of customer support ranging from our evaluation support program, which is available for 30 days, to our Premium Support Program, which includes access to technical support engineers 24 hours a day, seven days per week, for customers deploying mission critical applications. For an annual maintenance fee, customers are entitled to receive software updates, maintenance releases, online documentation and eServices including bug reports and unlimited technical support.

      Professional Services. The primary goal of our Professional Services organization is to ensure customer satisfaction and the successful implementation of our application solutions. ATG Professional Services has developed an Adaptive Delivery Framework (ADF) to ensure consistent, high-quality service delivery throughout all our project engagements. The ADF is used to create repeatable delivery processes from project to project to provide a consistent look and feel for all ATG project deliverables. Our Professional Services include four primary service offerings:

      Application Hosting Services. We offer our customers hosting services for the full spectrum of ATG applications. These services include the provisioning, management and monitoring of the application infrastructure including bandwidth, network, security, servers, operating system, enabling software, and ATG applications. In addition, we support our hosted customers on a 24 hours a day, seven days per week basis providing problem resolution services, application change management services, and the support for service level agreements related to application availability. Our application hosting services are available for a fee to customers that have purchased ATG product licenses in our Managed Services program. Alternatively, customers can elect our subscription-based OnDemand model. ATG OnDemand requires no investment in software licenses or maintenance agreements. The customer pays an initial set-up fee, and after a brief implementation period the solution is running from our data center. For the OnDemand offerings, we control the implementation and management process.

      Education Services. We provide a broad selection of educational programs designed to train customers and partners on our applications. This curriculum addresses the educational needs of developers, technical

managers, business managers, and system administrators. ATG Education Services also offers an online learning program that complements our instructor-led training. Developers can become certified on our base product or our commerce product by taking a certification exam in a proctored environment. We also measure partner quality using a partner accreditation program that ensures ATG partners have the skills necessary to effectively assist our clients with implementations. We provide a full range of instructor-led solutions to assist clients with these key initiatives.

Markets

      Our principal target markets are Global 2000 companies, government organizations, and other businesses that have large numbers of online users and utilize the Internet as a primary business channel. Our clients represent a broad spectrum of enterprises within diverse industry sectors. The following is a partial list:

Consumer Retail			Financial Services			Manufacturing
American Eagle Outfitters			Allstate			Abbott Laboratories
Body Shop			Barclays Global Investors			Boeing
Best Buy Companies, Inc.			Citicorp			Eastman Kodak
Cabela’s			Conseco			General Motors
Footlocker			Deutsche Bank			Newell Rubbermaid
J. Crew			Dreyfus Services Corporation			Nike
Neiman Marcus			Fidelity			Procter & Gamble
Office Max			Ford Motor Credit
Restoration Hardware			John Hancock Funds
Target Corporation			HSBC
The Finish Line			MFS Investment Management
Walgreens			Merrill Lynch
			Pioneer Investments

Communications and Technology			Travel Media and Entertainment			International
Adobe			American Airlines			Airbus
BellSouth			BMG Direct			BBC Worldwide, Ltd.
Cingular			Elsevier			Direkt Anlage Bank
EMC			Hilton Hotels			Deutsche Post
Palm One			Hotels.com			France Telecom
Hewlett Packard			Hyatt			Heidelberger Druckmaschinen
Hitachi			Intercontinental Hotels Group			Hoffman la Roche
Intuit			Knight-Ridder			IBM
Microsoft			Media News Group			Kingfisher
T-Mobile			Meredith Corporation			Lavazza
Verisign			Nintendo			Louis Vuitton
			Reader’s Digest			Orange PLC
			Nokia			Pirelli
			The MTVi Group			Philips
			Time, Inc.			Premier Farnell
			Warner Music			Royal Mail
						Telefonica
						Vodafone

Research and Development

      Our research and development group is responsible for core technology, product architecture, product development, quality assurance, documentation and third-party software integration. This group also assists with pre-sale, customer support activities and quality assurance tasks supporting the services and sales organizations.

      Since we began focusing on selling software products in 1996, the majority of our research and development activities have been directed towards creating new versions of our products, which extend and enhance competitive product features. In 2005, we focused primarily on developing new and innovative applications, as well as integrating our products with external enterprise data sources. In September 2005, we released our Wisdom application suite, combining the ATG and Primus products. The Wisdom suite combines integrated solutions on a common platform to offer customer service/support, commerce and marketing. In line with these efforts, we have developed several new applications and aligned our research and development resources accordingly.

Sales and Marketing

      We market and sell our products primarily through our direct sales force and through channel partners, including systems integrators and other technology partners. Our direct sales force is compensated based on product and services sales made to our clients, directly or through business partners. As of December 31, 2005, our sales organization included 68 direct sales representatives, inside sales representatives, managers, and sales support personnel.

      To increase the effectiveness of our sales group, we build awareness of our products through marketing programs. These programs include industry and partner events, market research, public relations activities, seminars, advertisements, direct mailings and the development of our website. Our marketing organization supports the sales process and helps identify key strategic alliances and other opportunities. They prepare product research, product planning, manage press coverage and other public relations. As of December 31, 2005, our marketing organization included 13 individuals.

      As of December 31, 2005, in addition to offices throughout the United States, we had sales offices located in the United Kingdom, Northern Ireland and France.

Strategic Alliances

      We have established strategic alliances with system integrators, technology partners and resellers to augment our direct sales activities.

      Consulting and System Integration Partners: We work closely with leading systems integrators, consulting firms and outsourcing firms. Our systems integrator partners are involved in most of our implementations. We believe that the support of these systems integrators for our products is increasingly important in influencing new customers’ decisions to license our products. Our systems integration partners include Accenture, HCL Technologies and IBM Business Consulting Services.

      Technology Partners: We maintain technology partnerships with Sun Microsystems, IBM, and JBoss.

      Resellers: We have reseller relationships with Allstream, EDS, Immix Technology, Group Inc., Professional Access, and McFadyen in North America; Al-Faris Information Technologies, AMG.net, Channels Overseas, DeltaDator, E-Tree, iO Tech, and Portal Technologies Systems in Europe, Middle East and Africa; and D2C2 Taiwan Limited, Hewlett-Packard Japan, Rikei and Professional Access in Asia.

      We provide our systems integrators, technology partners and resellers with sales and technical training in order to encourage them to create demand for our products and to extend our presence globally and regionally. Our sales training includes an introduction to our company and an overview of our products’ functionality, competitive advantages, packaging and pricing. We also provide this training to business development personnel, project managers, alliance managers and sales representatives employed by our channel partners.

      We provide technical training to developers, architects and project managers at our learning centers or on-site at channel partners’ premises. This training typically extends for a minimum of two-weeks. In addition, we encourage our channel partners to enroll in our accreditation and certification programs:

Competition

      The market for online sales, marketing and customer-service software is intensely competitive, subject to rapid technological change, and significantly affected by new product introductions and other market activities. We expect competition to persist and intensify in the future. We currently have the following primary sources of competition:

      We compete against these alternative products and services by providing a solution that enables our clients to provide their customers with an integrated customer experience for online sales, marketing and customer-service. We believe our solutions provide our clients with a rapid return on investment, attractive long-term total cost of ownership, a way to present a single view of themselves to their customers, the ability to improve the productivity and effectiveness of customer interactions, and the flexibility to adapt to rapidly changing and often unpredictable market needs.

      We seek to provide our clients with a rapid return on investment through out-of-the-box functionality for online sales (e-commerce), marketing and service built on a flexible, component architecture that is practical and cost-effective to customize. These capabilities can enable our clients to get to market quickly in a manner that exploits their competitive advantages, which helps drive their return on investment.

Proprietary Rights and Licensing

      Our success and ability to compete depends on our ability to develop and protect the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret, copyright law and contractual restrictions to protect our proprietary technology. We currently have 5 issued United States and 6 issued European patents covering our technology, and we have 12 additional patent applications pending, one of which has been allowed, but not issued. In addition, we have several trademarks that are registered or pending registration in the U.S. or

abroad. These legal protections afford only limited protection for our technology. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed license, “click through” or “shrink wrap” agreements, which impose restrictions on the licensee’s ability to use the software, such as prohibiting reverse engineering and limiting the use of copies. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements and by restricting access to our source code. Due to rapid technological change, we believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements to existing products are more important than legal protections to establish and maintain a technology leadership position.

Employees

      As of December 31, 2005, we had a total of 309 employees. Of our employees, 91 were in research and development, 81 in sales and marketing, 97 in services and 40 in general and administrative. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense. In addition, under outsourcing arrangements we employ the services of approximately 51 persons at centers in India and Belarus who perform product development and sustaining engineering activities. From time to time, we also employ independent contractors to support our professional services, product development, sales, marketing and business development organizations. Our employees are not represented by any collective bargaining unit, and we have never experienced a work stoppage. We believe our relations with our employees are good.

Internet Address and SEC Reports

      We maintain a website with the address www.atg.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the SEC. We also include on our website the charters for each of the major committees of our board of directors. In addition, we intend to disclose on our website any amendments to, or waivers from, our code of business conduct and ethics that are required to be publicly disclosed pursuant to rules of the SEC and Nasdaq.

      This annual report contains forward-looking statements, including statements about our growth and future operating results. For this purpose, any statement that is not a statement of historical fact should be considered a forward-looking statement. We often use the words “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions to help identify forward-looking statements. Forward-looking statements involve risks, uncertainties and assumptions.

      There are a number of important factors that could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this annual report.

Risks Related To Our Business

      Our revenues and operating results have varied from quarter to quarter in the past, and are likely to vary significantly from quarter to quarter in the foreseeable future. If our quarterly or annual results fall below our

expectations and those of securities analysts, the price of our common stock is likely to fall. A number of factors are likely to cause variations in our operating results, including:

      Accordingly, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. The results of one quarter or a series of quarters should not be relied upon as an indication of our future performance.

      Our hosting solution business is at an early stage of development and it is uncertain whether we will achieve and sustain demand for our hosted offerings. Our success in this effort will depend in part on the price, performance and availability of competing products and services and the willingness of companies to increase their use of hosting applications. Many companies have invested substantial personnel and financial resources to integrate traditional enterprise software into their businesses and such companies may be reluctant or unwilling to migrate to a hosting model. While we will continue to market and sell traditional licenses for our software solutions, we believe that the widespread market acceptance of our hosting software solutions is important to the success of our business because of the growth opportunities.

      Our hosting solution business is at an early stage of development and any equipment failures, mechanical errors, spikes in usage volume and/or failure to follow system protocols and procedures could cause our systems to fail, resulting in interruptions in our clients’ service to their customers. Any such interruptions or delays in our hosting services, whether as a result of third-party error, our own error, natural disasters or security breaches, whether accidental or willful, could harm our relationships with clients and our reputation. This in turn could reduce our revenue, subject us to liability cause us to issue credits or to pay penalties or cause our clients to decide not to renew their hosting agreements any of which could adversely affect our business, financial condition and results of operations.

      Under our OnDemand hosting service option for customers, the customer uses ATG hosting services and pays a subscription-based fee for the use of the product license. Under SOP 97-2 the revenues related to the license portion of the service are recognized ratability over the hosting period. If a greater than expected number of our customers were to select OnDemand, our product license revenues would decrease in the near term as the license fee is deferred and recognized ratably over the hosting period. This could result in our revenue and cash flow in 2006 or subsequent periods being less than we had forecast, which could negatively affect our share price.

      In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. Companies providing Internet-related products and services are increasingly bringing and becoming subject to suits alleging infringement of proprietary rights, particularly patent rights. We could incur substantial costs in prosecuting or defending any intellectual property litigation. If we sue to enforce our rights or are sued by a third party that claims that our technology infringes its rights, the litigation could be expensive and could divert our management resources. For example, both ATG and our Primus subsidiary have been involved in litigation alleging that we have infringed United States patents owned by third parties. We may be required to incur substantial costs in defending infringement litigation in the future, which could have a material adverse effect on our operating results and financial condition.

      In addition, we have agreed to indemnify customers against claims that our products infringe the intellectual property rights of third parties. From time to time, our customers have been subject to third party patent claims and we have agreed to indemnify such customers from such claims to the extent the claims related to our products. The results of any intellectual property litigation to which we might become a party may force us to do one or more of the following:

      We seek to protect the source code for our proprietary software under a combination of patent, copyright and trade secrets law. However, because we make the source code available to some customers, third parties may be more likely to misappropriate it. Our policy is to enter into confidentiality agreements with our employees, consultants, vendors and customers and to control access to our software, documentation and other proprietary information. Despite these precautions, it may be possible for someone to copy our software or other proprietary information without authorization or to develop similar software independently.

      Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and while we are unable to determine the extent to which piracy of our software exists; software piracy can be expected to be a persistent problem. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. However, the laws of many countries do not protect proprietary rights to as great an extent as the laws of the United States. Any such resulting litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results and financial condition. There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. Any failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, operating results and financial condition.

      Finally, our professional services may involve the development of custom software applications for specific customers. In some cases, customers retain ownership or impose restrictions on our ability to use the technologies developed from these projects. Issues relating to the ownership of software can be complicated, and disputes could arise that affect our ability to resell or reuse applications we develop for customers.

      We incurred losses in the second quarter of 2005, the first, second and fourth quarters of 2004, and in the first and third quarters of 2003. As of December 31, 2005, we had an accumulated deficit of $199.5 million. Although our revenues increased 31% to $90.6 million for the year ended December 31, 2005 compared with $69.2 million for the year ended December 31, 2004, this was primarily attributable to our acquisition of Primus. Our revenues decreased 5% to $69.2 million for the year ended December 31, 2004 compared with $72.5 million for the year ended December 31, 2003. Because we operate in a rapidly evolving industry, we have difficulty predicting our future operating results and we cannot be certain that our revenues will grow or our expenses will decrease at rates that will allow us to achieve profitability on a quarterly or annual basis. Additionally, we may experience other adverse effects on our revenue, net income and cash flows, which could result in a decline in the price of our common stock.

      Members of our management team, including executives with significant responsibilities in our finance, sales, marketing and research and development operations and executives of our acquired Primus subsidiary, have left us during the past few years for a variety of reasons. We cannot assure you that there will not be additional departures in the future. These changes in management, and any future similar changes, may be disruptive to our operations or affect our ability to maintain effective internal controls over financial reporting. In addition, equity incentives such as stock options constitute an important part of our total compensation program for management, and the volatility or lack of positive performance of our stock price may from time to time adversely affect our ability to retain our management team or hire replacements.

      We rely heavily on our direct sales force. Changes in the structure of our sales force have historically resulted in temporary lack of focus and reduced productivity.

      Our long sales cycle, which can often take several months or more, makes it difficult to predict the quarter in which sales may occur. We have a long sales cycle because we generally need to educate potential customers regarding the use and benefits of our products and services. Our sales cycle varies depending on the size and type of customer contemplating a purchase and whether we have conducted business with a potential customer in the past.

      We may incur significant sales and marketing expenses in anticipation of licensing our products, and if we do not achieve the level of revenues we expected, our operating results will suffer and our stock price may decline. These potential customers frequently need to obtain approvals from multiple decision makers prior to making purchase decisions. Delays in sales could cause significant variability in our revenues and operating results for any particular period.

      Like most software companies, a significant proportion of our sales are concentrated near the end of each fiscal quarter. Failure to close or be able to recognize revenues on even a relatively small number of license deals at quarter end can have a significant impact on our reported operating results for that quarter. This concentration of sales at quarter end can also lead to customer pressure to provide higher price discounts than anticipated. In addition, there can be no assurance that deals that are not closed at the end of a fiscal quarter, will be entered into during any subsequent quarter.

      The market for online marketing, sales and services applications is intensely competitive, and we expect competition to intensify in the future. This level of competition could reduce our revenues and result in increased losses or reduced profits. Our primary competition currently comes from in-house development efforts by potential customers or partners, as well as from other vendors of Web-based application software. We currently compete with e-commerce and marketing vendors such as IBM, RightNow Technologies, Amazon.com, Unica and GSI Commerce.

      The market for our service products is also rapidly evolving, and intensely competitive. Our suite of service products competes against various vendor software tools designed to address a specific element or elements of the complete set of eService processes, including e-mail management, support, knowledge management, and Web-based customer self-service and assisted service. We also face competition from in-house designed products and third-party custom development efforts. The high level of competition in this market has resulted in pricing pressures, which if such conditions continue or increase, could harm our results of operations. Some of the companies providing advanced natural language self service and traditional service resolution management solutions that may compete with us include eGain, Inquira, Kana, and Knova.

      In addition, competition may increase as a result of current competitors expanding their product offerings, new companies entering the market, software industry consolidations and formations of alliances among industry participants or with third parties. Many of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we do and may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Also, many current and potential competitors have greater name recognition and more extensive customer bases that they can use to gain market share. These competitors may be able to undertake more extensive promotional activities, adopt more aggressive pricing policies and offer more attractive terms to purchasers than we can. Moreover, our current and potential competitors may bundle their products in a manner that may discourage users from purchasing our products. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to enhance their products and expand their markets. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

      Competition could materially and adversely affect our ability to obtain revenues from license fees from new or existing customers and professional services revenue from existing customers. Further, competitive pressures could require us to reduce the price of our software products. In either case, our business, operating results and financial condition would be materially and adversely affected.

      Historically, we have derived a significant portion of our revenues from existing customers that purchase our support and maintenance services and enhanced versions of our products. Retention of our existing customer base requires that we provide high levels of customer service and product support to help our customers maximize the benefits that they derive from our products. To compete, we must introduce enhancements and new versions of our products that provide additional functionality. Further, we must manage the transition from our older products so as to minimize the disruption to our customers caused by such migration and integration with the customers’ information technology platform. If we are unable to continue to obtain significant revenues from our existing customer base, our ability to grow our business would be harmed and our competitors could achieve greater market share.

      As of December 31, 2005, we had offices in the United Kingdom, France and Northern Ireland. We derived 24% of our total revenues in the year ended December 31, 2005 from customers outside the United States. Our operations outside North America are subject to additional risks, including:

      The impact of future exchange rate fluctuations on our operating results cannot be accurately predicted. We may increase the extent to which we denominate arrangements with international customers in the currencies of the countries in which the software or services are provided. From time to time we may engage in hedges of contracts denominated in foreign currencies. Any hedging policies implemented by us may not be successful, and the cost of these hedging techniques may have a significant negative impact on our operating results.

      In the fourth quarter of 2005, we amended our $20.0 million line of credit to extend its expiration date from December 24, 2005 to February 7, 2006. The credit facility required net profitability of at least $1.00 for the fourth quarter of 2005. In February 2006 we renewed and amended the line of credit, and extended its expiration date until January 31, 2008. This line of credit is secured by all of our tangible and intangible intellectual and personal property and is subject to financial covenants including liquidity coverage and profitability. While there were no outstanding borrowings under the facility at December 31, 2005, our bank had issued letters of credit totaling $6.1 million, which are supported by this facility. The letters of credit have been issued in favor of various landlords to secure obligations pursuant to leases expiring through January 2009.

      The liquidity covenant in the line of credit mandates that we maintain cash, cash equivalents and marketable securities of $20 million at the end of each month. The profitability covenant, as amended, requires net profitability of at least $1.00 for the first quarter of 2006 and a net profitability of at least $500,000 for the second quarter of 2006 and for each quarter thereafter. In the event that we do not comply with the financial covenants within the line of credit or default on any of its provisions, the bank’s significant remedies include declaring all obligations immediately due and payable and ceasing to advance money or extend credit for our benefit.

      Accordingly, if we do not comply with any of the financial covenants in the line of credit or if our line of credit agreement expires, the bank may require the outstanding letters of credit to be cash secured. If the bank required us to secure each outstanding letter of credit on a dollar for dollar basis, our cash, cash equivalents and marketable securities balances would decrease substantially and our liquidity could be materially impaired.

      Since our potential customers often rely on third-party systems integrators to develop, deploy and manage websites for conducting commerce on the Internet, we cultivate relationships with systems integrators to encourage them to support our products. Approximately 42% of our product license revenues in 2005 resulted directly from our relationships with system integrators and value added resellers. We do not, however, have written agreements with our systems integrators, and they are not required to implement solutions that include our products or to maintain minimum sales levels of our products. Our revenues would be reduced if we fail to train a sufficient number of systems integrators adequately or if systems integrators devote their efforts to integrating or co-selling products of other companies. Any such reduction in revenue would not be accompanied by a significant offset in our expenses. As a result, our operating results would suffer and the price of our common stock probably would fall.

      We sell products through resellers. In some instances, we target our direct selling efforts toward markets that are also served by some of these resellers. This competition may limit our ability to sell our products and services directly in these markets and may jeopardize, or result in the termination of, these relationships.

      In addition to our acquisition of Primus, in the future, we may pursue additional acquisitions to obtain complementary businesses, products, services or technologies. Any such acquisition may not produce the revenues, earnings or business synergies that we anticipated, and an acquired business, product, service or technology might not perform as we expected. If we pursue an additional acquisition, our management could spend a significant amount of time and effort in identifying and completing the acquisition. If we complete an additional acquisition, we may encounter significant difficulties and incur substantial expenses in integrating the operations and personnel of the acquired company into our operations while preserving the goodwill of the acquired company. In particular, we may lose the services of key employees of the acquired company and we may make changes in management that impair the acquired company’s relationships with employees and customers.

      Any of these outcomes could prevent us from realizing the anticipated benefits of our additional acquisitions. To pay for an acquisition, we might use stock or cash. Alternatively, we might borrow money from a bank or other lender. If we use our stock, our stockholders would experience dilution of their ownership interests. If we use cash or debt financing, our financial liquidity would be reduced. We may be required to capitalize a significant amount of intangibles, including goodwill, which may lead to significant amortization charges. In addition, we may incur significant, one-time write offs and amortization charges. These amortization charges and write offs could decrease our future earnings or increase our future losses.

      We may need to raise additional funds in the future, for example, to develop new technologies, support an expansion, respond to competitive pressures, acquire complementary businesses or respond to unanticipated situations. We may try to raise additional funds through public or private financings, strategic relationships or other arrangements. Our ability to obtain debt or equity funding will depend on a number of factors, including market conditions, our operating performance and investor interest. Additional funding may not be available to

us on acceptable terms or at all. If adequate funds are not available, we may be required to revise our business plan to reduce expenditures, including curtailing our growth strategies, foregoing acquisitions or reducing our product development efforts. If we succeed in raising additional funds through the issuance of equity or convertible securities, the issuance could result in substantial dilution to existing stockholders. If we raise additional funds through the issuance of debt securities or preferred stock, these new securities would have rights, preferences and privileges senior to those of the holders of our common stock. The terms of these securities, as well as any borrowings under our credit agreement, could impose restrictions on our operations.

      The market for our products is marked by rapid technological change, frequent new product introductions and Internet-related technology enhancements, uncertain product life cycles, changes in customer demands, coalescence of product differentiators, product commoditization and evolving industry standards. We may not be able to develop and market or acquire new products or product enhancements that comply with present or emerging Internet technology standards and to differentiate our products based on functionality and performance. In addition, we may not be able to establish or maintain strategic alliances with operating system and infrastructure vendors that will permit migration or upgrade opportunities for our current user base. New products based on new technologies or new industry standards could render our existing products obsolete and unmarketable. For example, functionality that once differentiated our products over time has been incorporated into products offered by the major operating system and infrastructure providers, as occurred in the case of our application server products, leading to our recent decision to discontinue active marketing of these products.

      To succeed, we will need to enhance our current products, develop new products on a timely basis to keep pace with developments related to Internet technology and to satisfy the increasingly sophisticated requirements of customers and leverage strategic alliances with third parties in the e-commerce field who have complementary or competing products. E-commerce technology is complex and new products and product enhancements can require long development and testing periods. Any delays in developing and releasing new or enhanced products could cause us to lose revenue opportunities and customers.

      Complex software products such as ours often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. At the end of the third quarter of we released our Wisdom enabled Service Suite. This is a comprehensive set of Applications that provide a full-featured, adaptively customized environment for managing all forms of customer service interactions with individual attention. Despite internal testing and testing by customers, our current and future products may contain serious defects. Serious defects or errors could result in lost revenues or a delay in market acceptance.

      Since our customers use our products for critical business applications such as e-commerce, errors, defects or other performance problems could result in damage to our customers. They could seek significant compensation from us for the losses they suffer. Although our license agreements typically contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate these limitations. Even if not successful, a product liability claim brought against us would likely be time consuming and costly.

      We have entered into original equipment manufacturer, or OEM, agreements with IBM and JBoss, Inc., under which we have agreed to offer IBM’s WebSphere Internet infrastructure software and JBoss’ application server products, respectively as part of packaged software offerings. Market acceptance of these

relationships is subject to a number of significant risks, many of which are outside our control. These risks include:

      If our relationships with IBM and JBoss do not achieve market acceptance, our business and operating results may be harmed.

      During 2005, we incurred a net restructuring charge of $885,000, primarily due to a $1.8 million charge related to the relocation of our San Francisco office, offset by net reversals of $932,000 due to changes in estimates of prior restructuring charges. At the end of 2004, we initiated a plan to effect a worldwide headcount reduction and a reduction in the amount of space we occupy in our headquarters facility in Cambridge, Massachusetts. The 2004 action resulted in a net restructuring charge of $3.6 million, which included costs of employee severance and lease costs associated with vacated premises. During 2003, we had corporate restructurings involving workforce reductions and closures of excess facilities. In addition, there were changes in assumptions and estimates connected to prior restructuring charges and the leases that were settled during the period. These actions and changes in estimates of previous restructuring charges resulted in a net restructuring benefit of $10.5 million during 2003. In January 2003, we publicly announced a corporate restructuring involving a workforce reduction and the closing and consolidation of office facilities in selected locations. These actions resulted in recording a restructuring charge of $19.0 million in the fourth quarter of 2002. In addition, we recorded restructuring charges of $75.6 million in 2001. The outcomes of such restructuring activities are difficult to predict. While we believe our restructuring and consolidation activities will reduce our cost structure, we may not achieve the cost reductions that we are expecting. In addition, our restructuring activities may result in lower revenues as a result of the decreased staff in our sales and marketing and professional services groups or other adverse impacts on productivity that we did not anticipate.

      We rely in part on technology that we license from third parties, which is integrated into our internally developed software. Third-party technology licenses might not continue to be available to us on commercially reasonable terms, or at all. The loss of any significant technology license could cause delays in our ability to deliver our products or services until equivalent technology is developed internally or equivalent third-party technology, if available, is identified, licensed and integrated.

      We write our software in the Java computer programming language developed by Sun Microsystems and we incorporate Sun’s Java 2 Platform, Enterprise Edition, or J2EE, and Sun’s Java Runtime Environment,

Java Naming and Directory Interface, Java Servlet Development Kit, Java Foundation Classes, JavaMail and JavaBeans Activation Framework into our products under licenses granted to us by Sun. Our Version 7 ATG Adaptive Scenario Engine has been designed to support Sun’s J2EE standards. If Sun were to decline to continue to allow us to use these technologies for any reason, we would be required to either license the equivalent technology from another source, create equivalent technology ourselves, or rewrite portions of our software to accommodate the change.

      While a number of companies have introduced Web applications based on Java, Java could fall out of favor, and support by Sun Microsystems or other companies could decline. Moreover, our new Version 7 ATG Adaptive Scenario Engine is designed to support J2EE standards for developing modular Java programs that can be accessed over a network. We have licensed the J2EE brand and certification tests from Sun. There can be no assurance that these standards will be widely adopted, that we can continue to support J2EE standards established by Sun from time to time or that the J2EE brand will continue to be made available to us on commercially reasonable terms. If Java or J2EE support decreased or we could not continue to use Java or related Java technologies or to support J2EE, we might have to rewrite the source code for our entire product line to enable our products to run on other computer platforms. Also, changes to Java or J2EE standards or the loss of our license to the J2EE brand could require us to change our products and adversely affect the perception of our products by our customers. If we were unable to develop or implement appropriate modifications to our products on a timely basis, we could lose revenue opportunities and our business could be harmed.

Risks Related To the Internet Industry

      Our success will depend heavily on the continued use of the Internet for e-commerce. If the market for our products and services fails to mature, we will be unable to execute our business plan. Adoption of electronic commerce and online marketing, sales and service applications, particularly by those companies that have historically relied upon traditional means of commerce, requires a broad acceptance of different methods of conducting business. Our future revenues and profits will substantially depend on the Internet continuing to be accepted and widely used for commerce and communication. If Internet commerce does not continue to grow or grows more slowly than expected, our future revenues and profits may not meet our expectations or those of analysts. Similarly, purchasers with established patterns of commerce may be reluctant to alter those patterns or may otherwise resist providing the personal data necessary to support our consumer profiling capability.

      As e-commerce evolves, federal, state and foreign agencies could adopt regulations covering issues such as user privacy, content and taxation of products and services. If enacted, government regulations could limit the market for our products and services or could impose burdensome requirements that render our business unprofitable. Although many regulations might not apply to our business directly, we expect that laws regulating the solicitation, collection or processing of personal and consumer information could indirectly affect our business. The Telecommunications Act of 1996 prohibits certain types of information and content from being transmitted over the Internet. The prohibition’s scope and the liability associated with a violation are currently unsettled. In addition, although substantial portions of the Communications Decency Act were held to be unconstitutional, we cannot be certain that similar legislation will not be enacted and upheld in the future. It is possible that legislation could expose companies involved in e-commerce to liability, which could limit the growth of e-commerce generally. Legislation like the Telecommunications Act and the Communications Decency Act could dampen the growth in Web usage and decrease its acceptance as a medium of communications and commerce.

      Businesses use our ATG Adaptive Scenario Engine product to develop and maintain profiles to tailor the content to be provided to website visitors. When a visitor first arrives at a website, our software creates a profile for that visitor. If the visitor registers or logs in, the visitor’s identity is added to the profile, preserving any profile information that was gathered up to that point. ATG Adaptive Scenario Engine product tracks both explicit user profile data supplied by the user as well as implicit profile attributes derived from the user’s behavior on the website. Privacy concerns may cause visitors to resist providing the personal data or to avoid websites that track the Web behavioral information necessary to support our profiling capability. More importantly, even the perception of security and privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our products. In addition, legislative or regulatory requirements may heighten these concerns if businesses must notify website users that the data captured after visiting websites may be used to direct product promotion and advertising to that user. Other countries and political entities, such as the European Economic Community, have adopted such legislation or regulatory requirements. The United States may adopt similar legislation or regulatory requirements. If privacy legislation is enacted or consumer privacy concerns are not adequately addressed, our business, financial condition and operating results could be harmed.

      Our products use “cookies” to track demographic information and user preferences. A “cookie” is information keyed to a specific user that is stored on a computer’s hard drive, typically without the user’s knowledge. Cookies are generally removable by the user, although removal could affect the content available on a particular site. Germany has imposed laws limiting the use of cookies, and a number of Internet commentators and governmental bodies in the United States and other countries have urged passage of laws limiting or abolishing the use of cookies. If such laws are passed or if users begin to delete or refuse cookies as a common practice, demand for our personalization products could be reduced.

Risks Related to the Securities Markets and Our Stock

      The market price of our common stock has fluctuated in the past and is likely to continue to be highly volatile. For example, the market price of our common stock has ranged from $0.58 per share to $126.88 per share since our initial public offering in July 1999 and has ranged from $0.92 per share to $2.13 per share between January 1, 2005 and December 31, 2005. Fluctuations in market price and volume are particularly common among securities of Internet and software companies. The market price of our common stock may fluctuate significantly in response to the following factors among others, some of which are beyond our control:

      We currently are the subject of securities class action litigation. In addition, our Primus subsidiary is also subject to a securities class action litigation. If a court awards damages to the plaintiffs in these cases, the total amount could exceed the limit of our existing insurance. These litigations also may divert management’s attention and resources. For a further description of the pending litigation, see “Part II, Item 1. Legal

Proceedings.” We may be the target of similar litigation in the future if the market for our stock becomes volatile. While we believe that we have an appropriate amount of insurance for class action lawsuits, we cannot be certain that the insurance coverage will be available or, if available, sufficient to cover our liability with respect to a specific future action that may be brought.

      For our common stock to trade on the Nasdaq National Market, we must continue to meet the listing standards of that market. Among other things, those standards require that our common stock maintain a minimum closing bid price of at least $1.00 per share. As recently as October 2005, our common stock has traded at prices near and below $1.00. If we do not continue to meet Nasdaq’s applicable minimum listing standards, Nasdaq could delist us from the Nasdaq National Market. If our common stock is delisted from the Nasdaq National Market, we could seek to have our common stock listed on the Nasdaq SmallCap Market. However, delisting of our common stock from the Nasdaq National Market could hinder your ability to sell, or obtain an accurate quotation for the price of, your shares of our common stock. Delisting could also adversely affect the perception among investors of ATG and its prospects, which could lead to further declines in the market price of our common stock. Delisting would also make it more difficult and expensive for us to raise capital. In addition, delisting might subject us to an SEC rule that could adversely affect the ability of broker-dealers to sell or make a market in our common stock, thus hindering your ability to sell your shares.

      Certain provisions of our charter and by-laws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable, which could reduce the market price of our common stock. These provisions include:

      In addition, we adopted a shareholder rights plan in 2001 and Delaware law may further discourage, delay or prevent someone from acquiring or merging with us.

      We are facing increased regulatory scrutiny associated with the highly publicized financial scandals and the various accounting and corporate governance rules promulgated under the Sarbanes-Oxley Act of 2002 and related regulations. Our management will continue to review and monitor all of the accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including those related to relationships with our independent auditors, enhanced financial disclosures, internal controls, board and board committee practices, corporate responsibility and executive officer loan practices, and intend to fully comply with such laws. Nevertheless, such increased scrutiny and penalties involve risks to both the Company

and its executive officers and directors in monitoring and ensuring compliance. A failure to properly navigate the legal disclosure environment and implement and enforce appropriate policies and procedures could harm the Company’s business and prospects, including its ability to recruit and retain skilled officers and directors. In addition, it may be adversely affected as a result of new or revised legislation or regulations imposed by the Securities Exchange Commission, other U.S. or foreign governmental regulatory authorities or self-regulatory organizations that supervise the financial markets. It also may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations.

      Section 404 of the Sarbanes Oxley Act of 2002 requires that we annually evaluate and report on our systems of internal controls and that our independent auditors must report on management’s evaluation of those controls. Management’s evaluation and the auditor’s report thereon is included in Item 9A of this Form 10-K. We cannot assure you that there will not in the future be significant deficiencies or material weaknesses in our internal controls that would be required to be reported. A negative reaction by the equity markets to the reporting of a significant deficiency or material weakness could cause our stock price to decline.

      We are also spending an increased amount of management time and focus as well as external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure. This has caused us to hire additional personnel and outside advisory services and has resulted in additional accounting and legal expenses. These additional expenses could adversely affect our operating results and the market price of our stock could suffer as a result.

      In addition, if in the future we acquire companies with weak internal controls, it will take time to get the internal controls of the acquired company up to the same level of operating effectiveness as ours. Our inability to address these risks could negatively affect our operating results.

      In accordance with Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, we are required to expense employee stock options for financial reporting purposes, effective for our 2006 fiscal year. Such stock option expensing will require us to value our employee stock option grants pursuant to an option valuation formula and amortize that value against our earnings over the vesting period in effect for those options. We currently account for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and have used the disclosure-only alternative of SFAS No. 123, Accounting for Stock-Based Compensation. We estimate the adoption of this accounting principle will affect our reported results of operations by at least $3.0 million to $4.0 million in 2006 as the stock-based compensation expense is charged directly against our reported earnings. This estimate is based on our current level of employees and related unvested stock options, expected level of employees and stock options to be granted in 2006, and participation in our employee stock purchase plan in 2006. For pro forma disclosure illustrating the effect such a change on our recent results of operations, see Note 1(m) of the Consolidated Financial Statements. The adoption of SFAS 123R could adversely affect our ability to comply with the profitability covenants of our credit facility with our bank. See Note 3 to the Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.

      Not applicable.

      Our principal administrative, research and development, sales, consulting, training and support facilities occupy approximately 44,000 square feet in Cambridge, Massachusetts, pursuant to a lease expiring in 2006. As a result, we may find it beneficial to move our principal offices in the second half of 2006. We anticipate any such relocation, if any at all, would be to comparable space within the same general vicinity and approximate price range. In addition, we occupy approximately 19,000 square feet in Seattle, Washington; 12,000 square feet in Chicago, Illinois 5,000 square feet in San Francisco, California and 7,000 square feet in Washington, D.C., pursuant to a lease expiring in 2006. Our European headquarters are located in Apex Plaza, Reading, United Kingdom where we lease approximately 8,000 square feet pursuant to a lease expiring in 2009.

      At December 31, 2005, we also had offices in Northern Ireland and France. Since 2001, we have reached several lease settlement agreements with landlords that significantly reduced our lease obligations. For further information concerning our lease restructuring activities and our obligations under all operating leases, see Note 10 and Note 7, respectively, of the Notes to our Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.

      We and certain of our former officers have been named as defendants in seven purported class action suits that have been consolidated into one action currently pending in the United States District Court for the District of Massachusetts under the caption In re Art Technology Group, Inc. Securities Litigation (Master File No. 01-CV-11731-NG). This case alleges that we, and certain of our former officers, have violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule SEC 10b-5 promulgated thereunder, which generally may subject issuers of securities and persons controlling those issuers to civil liabilities for fraudulent actions in connection with the purchase or sale of securities The case was originally filed in 2001, and a consolidated amended complaint was filed in March 2002. In April, 2002, we filed a motion to dismiss the case. On September 4, 2003, the court issued a ruling dismissing all but one of the plaintiffs’ allegations. The remaining allegation was based on the veracity of a public statement made by one of our former officers. In August 2004, we filed a renewed motion to dismiss and motion for summary judgment as to the remaining allegation, which the court granted in September 2005. The plaintiffs have moved for leave to file a second consolidated amended complaint, which, if allowed, would revive some of the claims previously dismissed by the court. The court has deferred a final order of dismissal of plaintiffs’ case to allow it time to consider plaintiffs’ motion for leave to file a second consolidated amended complaint. We have opposed that motion. Management believes that none of the claims that plaintiffs seek to assert in their second amended complaint has merit, and intends to continue to defend the action vigorously. While we cannot predict with certainty the outcome of the litigation, we do not expect any material adverse impact to our business, or the results of our operations, from this matter.

      Our wholly owned subsidiary Primus Knowledge Solutions, Inc., two former officers of Primus, and the underwriters of Primus’ initial public offering, have been named as defendants in an action filed in December 2001 in the United States District Court for the Southern District of New York under the caption In re Primus Knowledge Solutions, Inc. Securities Litigation, Civil Action 01-Civ.-11201 (SAS) on behalf of a purported class of purchasers of Primus common stock from June 30, 1999 to December 6, 2000, which was issued pursuant to the June 30, 1999 registration statement and prospectus for Primus’ initial public offering. The consolidated and amended complaint asserts claims under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) (and SEC Rule 10b-5 promulgated thereunder) and 20(a) of the Securities Exchange Act of 1934. This action is one of more than 300 similar actions coordinated for pretrial purposes under the caption In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. By action of a special committee of disinterested directors (who were neither defendants in the litigation nor members of Primus’s Board of Directors at the time of the actions challenged in the litigation), Primus decided to accept a settlement proposal presented to all issuer defendants. In the settlement, plaintiffs will dismiss and release all claims against Primus and the individual defendants in exchange for a contingent payment by the insurance

companies collectively responsible for insuring the issuers in all of the consolidated IPO cases, and for the assignment or release of certain potential claims that we may have against the underwriters. We will not be required to make any cash payments in the settlement, unless the pro rata amount paid by the insurers in the settlement on our behalf exceeds the amount of the insurance coverage, a circumstance that we believe is not likely to occur. A stipulation of settlement of claims against the issuer defendants, including Primus, was submitted to the Court for preliminary approval in June 2004. On August 31, 2005, the Court granted preliminary approval of the settlement. The settlement is subject to a number of conditions, including final Court approval after proposed settlement class members have an opportunity to object or opt out. If the settlement does not occur, and litigation against Primus continues, we believe we have meritorious defenses and intend to defend the case vigorously. While we cannot predict with certainty the outcome of the litigation or whether the settlement will be approved, we do not expect any material adverse impact to our business, or the results of our operations, from this matter.

      We are also subject to various other claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters is not expected to have a material effect on our business, financial condition or results of operations.

PART II

      Our common stock trades on the Nasdaq National Market under the symbol “ARTG.” The following table sets forth the high and low reported sales prices of our common stock for the periods indicated as reported by the Nasdaq National Market.

      On March 7, 2006 the last reported sale price on the Nasdaq National Market for our common stock was $2.80 per share. On March 7, 2006, there were approximately 623 holders of record of our common stock. This number does not include stockholders for whom our shares were held in a “nominee” or “street” name.

      We currently intend to retain future earnings, if any, to finance our growth. We do not anticipate paying cash dividends on our common stock in the foreseeable future. Payment of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, restrictions in financing agreements and plans for expansion.

Consolidated Statements of Operations Data:

Consolidated Balance Sheet Data:

Overview

      The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes contained in Item 8 of this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Item 1A. Risk Factors” and elsewhere in this report.

      We derive our revenues from the sale of software licenses and related services that help consumer-facing organizations create an interactive experience for their customers and partners via the Internet and other channels. Our software licenses are priced based on either the size of the customer implementation or site license terms. Services revenues are derived from fees for professional services, training, support and maintenance, and application hosting. Professional services include implementation, custom application development and project and technical consulting. We bill professional service fees primarily on a time and materials basis or in limited cases, on a fixed-price schedule defined in our contracts. Support and maintenance arrangements are priced based on the level of services provided. Generally, customers are entitled to receive software updates, maintenance releases as well as on-line and telephone technical support for an annual maintenance fee. Training is billed as services are provided. Revenue from application hosting services is recognized monthly as the services are provided. We market and sell our products worldwide through our direct sales force, systems integrators, technology alliances and original equipment manufacturers.

      As of December 31, 2005 we had offices in the United States, United Kingdom, France and Northern Ireland with sales personnel in the United States, United Kingdom and France. Revenues from customers outside the United States accounted for 24% of our total revenues in 2005, 33% in 2004 and 35% in 2003.

Critical Accounting Policies and Estimates

      This management’s discussion and analysis of financial condition and results of operations discusses 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 require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, the allowance for doubtful accounts, research and development costs, restructuring expenses, the impairment of long-lived assets and income taxes. Management bases its estimates and judgments on historical experience, known trends or events and various other factors 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 critical accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment.

      Not only is revenue recognition a key component of our results of operations, the timing of our revenue recognition also determines the timing of certain expenses, such as commissions. In measuring revenues, we follow the specific guidelines of Statement of Position (SOP) No. 97-2, Software Revenue Recognition and SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. SOP 97-2 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists via a signed license agreement; (2) physical or electronic delivery has occurred including the availability of license keys or services rendered; (3) the fee is fixed or determinable representing amounts that are due unconditionally with no future obligations under customary payment terms; and (4) collectibility is probable.

      In accordance with SOP 97-2 and SOP 98-9, revenues from software product license agreements are recognized upon execution of a license agreement and delivery of the software, provided that the fee is fixed or determinable and deemed collectible by management. If conditions for acceptance are required subsequent to delivery, revenues are recognized upon customer acceptance if such acceptance is not deemed to be perfunctory. In multiple element arrangements, we use the residual value method in accordance with SOP 97-2 and SOP 98-9. Revenue earned on software arrangements involving multiple elements which qualify for separate element accounting treatment is allocated to each undelivered element using the relative fair values of those elements based on vendor specific objective evidence with the remaining value assigned to the delivered element, the software license. Many of our software arrangements include consulting implementation services sold separately under consulting engagement contracts. Consulting revenues from these arrangements are generally accounted for separately from software licenses because the arrangements qualify as service transactions 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 (i.e., 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. Consequently, license fee revenue is generally recognized when the product is shipped. Revenues from software maintenance or hosting agreements are recognized ratably over the term of the maintenance or hosting period, which for application hosting and support and maintenance is typically one year. Customers who have purchased our product licenses and have also entered into a hosting agreement typically have a contractual right to cancel the hosting agreement with a minimum notice period. We account for these transactions in accordance with Emerging Issues Task Force (EITF) 00-3, Application of AICPA Statement of Position 97-2, Software Revenue Recognition, to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware, and generally recognize the product license fee upon delivery of the software license because we have established the fair value of a vendor specific objective evidence of hosting services, the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalties and it is feasible for the customer to run the software on its own hardware or contract with another party to host the software. We enter into reseller arrangements that typically provide for sublicense fees payable to us based upon a percentage of our list price. Revenues are recognized under reseller agreements based upon actual sales to the resellers. We do not grant our resellers the right of return or price protection.

      Revenues from professional service arrangements are recognized as the services are performed, provided that amounts due from customers are fixed or determinable and deemed collectible by management. Amounts collected prior to satisfying the above revenue recognition criteria are reflected as deferred revenue. Deferred revenue primarily consists of advance payments related to support and maintenance, hosting and service agreements.

      We principally charge for professional services revenues on a time-and-material basis. From time to time we enter into fixed-price service arrangements. In those circumstances in which services are essential to the functionality of the software, we apply the percentage-of-completion method, and in those situations when only professional services are provided, we apply the proportional performance method. Both of these methods require that we track the effort expended and the effort expected to complete a project. The most significant assumption by management in accounting for this type of arrangement is the estimated time to complete the project. Significant deviations in actual results from management’s estimates with respect to one or more projects could significantly affect the timing of revenue recognition and could result in significant losses on these projects. To date, our actual results in completing projects have not deviated significantly from management’s estimates of the time to complete those projects.

      We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We continuously monitor collections and payments from our customers and determine the allowance for doubtful accounts based upon historical experience and specific customer collection issues. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.

      We account for research and development costs in accordance with SFAS No. 2, Accounting for Research and Development Costs, and SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, which specifies that costs incurred internally to develop computer software products should be charged to expense as incurred until technological feasibility is reached for the product. Once technological feasibility is reached, all software costs should be capitalized until the product is made available for general release to customers. Judgment is required in determining when technological feasibility is established. We believe that the time period from reaching technological feasibility until the time of general product release is very short. Costs incurred after technological feasibility is reached are not material, and accordingly, all such costs are charged to research and development expense as incurred.

      During 2005, 2004, 2003, 2002 and 2001, we recorded net restructuring charges (benefits) of $0.9 million, $3.6 million, $(10.5) million, $19.0 million and $75.6 million, respectively, pertaining to the closure and consolidation of excess facilities, impairment of assets as discussed below, employee severance benefits and settlement of certain contractual obligations. These charges and benefits were recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits and Staff Accounting Bulletin (SAB) No. 100 (SAB 100), Restructuring and Impairment Charges. The 2002 and 2001 charges were recorded in accordance with Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), SFAS 88, and SAB 100. In determining the charges to record, we made certain estimates and judgments surrounding the amounts ultimately to be paid for the actions we have taken. At December 31, 2005, there were various accruals recorded for termination benefits and lease obligations, which may be adjusted periodically for either resolution of certain contractual commitments or changes in estimates of sublease income or the period of time the facilities will be vacant and subleased. Although we do not anticipate additional significant changes to our restructuring accruals, the actual costs may differ from those recorded in the event that the subleasing assumptions require adjustment. Such changes in estimates have had a material impact on our operating results in the past and could have a material impact on our operating results in the future.

      To estimate the costs related to our restructuring efforts, management made its best estimates of the most likely expected outcomes of the significant actions to accomplish the restructuring. These estimates principally related to costs attributable to excess leased facilities and included estimates of future sublease income, future

net operating expenses of the facilities, brokerage commissions and other expenses. The most significant of these estimates related to the timing and extent of future sublease income that would reduce our lease obligations.

      Included in our accrued restructuring balance at December 31, 2005 was estimated sublease income of $523,000. We based our estimate of sublease income on the status of current negotiations with a potential subtenant and current market conditions and rental rates for this location. Actual results may vary significantly from this estimate, depending in part on our ability to obtain approval of the sublease from the landlord. We review the status of our restructuring activities on a quarterly basis and, if appropriate, record adjustments to our restructuring obligations in our financial statements for such quarter based on management’s current best estimates.

      We review our long-lived assets, including intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of such an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to the future undiscounted cash flows the assets are expected to generate. If such assets are considered impaired, the impairment to be recognized is equal to the amount by which the carrying value of the assets exceeds their fair market value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. In assessing recoverability, we must make assumptions regarding estimated future cash flows and discount factors. If these estimates or related assumptions change in the future, we may be required to record impairment charges. Intangible assets with determinable lives are amortized over their estimated useful lives, based upon the pattern in which the expected benefits will be realized, or on a straight-line basis, whichever is greater.

      As a result of our restructuring activities in 2005, 2004, and 2003, we evaluated the realizability of our long-lived assets including fixed assets and leasehold improvements related to our restructured facility leases. In 2005, 2004, and 2003 we deemed leasehold improvements of approximately $118,000, $200,000 and $310,000, respectively, to be impaired due to the fact we had vacated the related office locations, and that the estimated sublease income at the location was not sufficient to recover the assets carrying value. In 2003, we determined that approximately $78,000 of computer equipment and furniture and fixtures were impaired as a result of our decision to abandon the assets because of the termination of employees and related closures of offices. Also in 2003, we determined that $169,000 of purchased software was impaired due to our revised product development strategy.

      Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired in a business combination. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company annually evaluates goodwill for impairment as well as whenever events or changes in circumstances suggest that the carrying amount may not be recoverable from estimated discounted future cash flows. Because the Company has one reporting segment under SFAS 142, the Company utilizes the entity-wide approach for assessing goodwill for impairment and compares the Company’s market value to its net book value to determine if impairment exists. No impairment of goodwill resulted from the Company’s evaluation of goodwill in any of the fiscal years presented.

      We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. We evaluate the realizability of our deferred tax assets quarterly and adjust the amount of such allowance, if necessary. At December 31, 2005 and 2004, we have provided a

full valuation allowance against our net deferred tax assets due to the uncertainty of their realizability. The valuation allowance increased $5.7 million to $119.4 million in 2005 from $113.7 million in 2004. The primary reason for the increase in the valuation allowance is due to an increase of $7.8 million related to tax credits and other temporary differences not previously included in gross deferred tax assets and a decrease of $2.1 million utilized to offset current year book income. If substantial changes in our ownership have occurred or should occur, or if we determine that there were ownership changes at Primus prior to our acquisition thereof, as defined by Section 382 of the Internal Revenue Code, there could be annual limitations on the amount of net operating loss carryforwards that can be realized in future periods.

      In addition, we have provided for potential amounts due in various foreign tax jurisdictions. Judgment is required in determining our worldwide income tax expense provision. In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement arrangements among related entities. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material impact on our income tax provision and operating results in the period in which such determination is made. During 2004 and 2003, we reversed previously accrued taxes of $158,000 and $332,000, respectively, for foreign locations, due to the closure of the statute of limitations, or as a result of changes in our estimates of potential amounts due, in those locations.

Results of Operations

      The following table sets forth statement of operations data as percentages of total revenues for the periods indicated:

      The following table sets forth, for the periods indicated, the cost of product license revenues as a percentage of product license revenues and the cost of services revenues as a percentage of services revenues:

      Total revenues increased 31% to $90.6 million in 2005 from $69.2 million in 2004. The increase was primarily attributable to our acquisition of Primus in November 2004 and the shift in our focus to marketing and selling application products rather than infrastructure products. Since 2004 our focus has been on e-commerce and service applications, and through our Primus acquisition, solutions that enable our customers to deliver a superior customer experience via contact centers, information technology help desks, web (intranet and Internet) self-service and electronic communication channels. The increase in revenues compared to 2004 was also partly attributable to our new application hosting services, which generated revenues of approximately $5.3 million in 2005 compared to $0.7 million in 2004. We expect revenue growth in 2006 resulting in revenues in the range of $97 million to $105 million.

      In 2004 total revenues decreased 5% to $69.2 million from $72.5 million in 2003. The decrease was primarily attributable to longer sales cycles, delayed purchasing decisions and reduced Information Technology related spending by our customers. Additionally, the transition in our marketing and sales focus from infrastructure products to application products, particularly in the e-commerce and self-service area, contributed to the decrease in revenues, as sales of our new application products were not initially sufficient to offset the reduction in sales of our older infrastructure products. Revenues generated from international customers decreased to $21.6 million or 23.9% of total revenues in 2005, from $22.8 million, or 33% of total revenues, in 2004 and from $25.3 million, or 35% of total revenues, in 2003. During the fourth quarter of 2005, one customer accounted for 16% of total revenues. No customer accounted for more than 10% of total revenues in 2005, 2004 or 2003.

      Product license revenues increased 28% to $29.8 million in 2005 from $23.3 million in 2004. The increase was primarily attributable to our acquisition of Primus in November 2004 and the shift in our focus of our marketing and selling efforts to applications products from infrastructure products.

      Product license revenues generated from international customers decreased to $7.4 million in 2005 from $9.4 million in 2004. The decrease in international revenues was due primarily due to timing of certain deals.

      Product license revenues decreased 14% to $23.3 million in 2004 from $27.2 million in 2003. The decrease was primarily attributable to longer sales cycles, delayed purchasing decisions and reduced Information Technology related spending by our customers, which affected both our infrastructure products business and our application products business and resulted in reduced sales volume in terms of both the number and size of transactions with customers. Additionally, the transition in our marketing and sales focus from infrastructure products to application products, particularly in the e-commerce and self-service area, contributed to the decrease in revenues. These decreases in revenues from our historical businesses were partially offset by two months of Primus revenues. The decline in product license revenues in 2004 as compared to 2003 is attributable to reduced sales volume of both the number and size of transactions with customers.

      Product license revenues as a percentage of total revenues for 2005, 2004 and 2003 were 33%, 34% and 37%, respectively. We expect this percentage to be in the range of 32% to 36% in 2006.

      Our resellers generally receive a discount from our list prices. The extent of any discount is based on negotiated contractual agreements between us and the reseller. We do not grant our resellers the right of return, price protection or favorable payment terms. We rely upon resellers to market and sell our products to governmental entities and to customers in geographic regions where it is not cost effective for us to reach clients directly. During 2005, we had approximately 15 active resellers. Reseller revenues and the percentage of revenues from resellers can vary significantly from period to period depending on the revenues from large deals, if any, closed through this channel during any period. No reseller accounted for more than 10% of our revenues for the years ended 2005, 2004 or 2003.

      The table below sets forth product revenues recognized from reseller arrangements for the years ended 2005, 2004 and 2003:

      Services revenues increased 33% to $60.8 million in 2005 from $45.9 million in 2004. The increase was attributable to new service revenues from the acquisition of Primus, including application hosting services of $5.3 million in 2005 compared to $0.7 million in 2004.

      Support and maintenance revenues were 64% of total services revenues in 2005 and 2004. Support and maintenance revenues, in absolute dollars, were higher during 2005 due to the addition of Primus’ active support and maintenance customer base, offset by a portion of existing ATG customers terminating their support coverage.

      We expect support and maintenance revenues to increase in 2006 because of increases in new maintenance revenues associated with expected 2006 product revenues, slightly offset by a portion of existing customers terminating their support coverage.

      Services revenues increased 1% to $45.9 million in 2004 from $45.3 million in 2003. The increase was attributable to increased professional services revenues and new services revenues from the acquisition of Primus, offset by decreased support and maintenance revenues.

      Support and maintenance revenues were 64% of total services revenues in 2004 as compared to 69% in 2003. Support and maintenance revenues, in absolute dollars, were lower in 2004 due to a combination of declining product revenues in prior periods and some customers electing to decrease or terminate their support coverage.

      Services revenues as a percentage of total revenues for 2005, 2004 and 2003 were 67%, 66%, and 63%, respectively. We expect services revenues to be higher in 2006 and to decrease slightly as a percentage of total revenues.

      Cost of product license revenues includes salary and related benefits of engineering staff and outsourced developers dedicated to the maintenance of products that are in general release, costs of fulfillment, external shipping cost, the amortization of licenses purchased in support of and used in our products, royalties paid to vendors whose technology is incorporated into our products and amortization expense related to acquired developed technology.

      Cost of product license revenues decreased 18% to $1.8 million in 2005 from $2.2 million in 2004. This decrease was primarily related to a reduction in salary and related costs along with decreased royalties paid on third party software embedded in our products, together totaling approximately $780,000. This was partially

offset by an increase in amortization expense of $376,000 related to developed technology, an intangible asset recorded as part of the Primus acquisition in November 2004.

      Cost of product license revenues increased 4% to $2.2 million in 2004 from $2.1 million in 2003. This increase was primarily related to amortization expense of $441,000 related to developed technology, an intangible asset recorded as part of the Primus acquisition in November 2004, partially offset by decreased salaries and related costs and decreased royalties paid on third party software embedded into our products. Also, a $169,000 charge recorded in 2003, as a result of our determination that certain purchased software was impaired due to a change in our product development strategy, did not recur in 2004.

      For 2005, 2004 and 2003, gross margin on product license revenues was 94%, or $28.0 million, 91%, or $21.1 million, and 92%, or $25.0 million, respectively. The increase in gross margin percentage in 2005 compared to 2004 is due to higher product revenues in 2005 and lower salaries and royalties of $780,000 offset by an increase in amortization expense of $376,000 related to developed technology from the Primus acquisition. The decrease in gross margin percentage in 2004 compared to 2003 is due to amortization expense of $441,000 related to developed technology from the Primus acquisition.

      Cost of services revenues includes salary and other related costs for our professional services, technical support staff and hosting services as well as third-party contractor expenses. Cost of services revenues will vary significantly from year to year depending on the level of professional services staffing, the effective utilization rates of our professional services staff, the mix of services performed, including product license technical support services, the extent to which these services are performed by us or by third-party contractors and the level of third-party contractor fees.

      Cost of services revenues increased 17% to $23.3 million in 2005 from $19.9 million in 2004. The increase was primarily attributable to an increase in service revenues of 33% for the year and a full year of hosting activities; resulting in an increase in salaries and benefits and increased use of third party contractors. Our use of outside contractors increased by $1.2 million compared to 2004.

      Cost of services revenues increased slightly to $19.9 million in 2004 from $19.8 million in 2003. The increase was primarily attributable to an increase in salaries and outside professional services costs, offset by reduced rent expense, operating costs and infrastructure expenses as a result of our restructuring efforts. Our use of outside contractors increased by $800,000 compared to 2003.

      For 2005, 2004 and 2003, gross margin on services revenues was 62%, or $37.6 million, 57%, or $26.0 million, and 56%, or $25.5 million, respectively. The increase in gross margin in 2005 compared with 2004 was attributed primarily to continued use of third party contractors to control costs. Gross margin remained relatively flat in 2004 compared with 2003. We expect gross margin on services revenues in 2006 to be in the 60% to 64% range.

      Research and development expenses consist primarily of salary and related costs to support product development, as well as costs related to outsourcing services. To date, all software development costs have been expensed as research and development in the period incurred.

      Research and development expenses increased 10% to $17.8 million in 2005 from $16.2 million in 2004. The increase was primarily attributable to an increase in our use of third party offshore contractors and to higher third party and consultant fees, which increased by $1.6 million during year ended December 31, 2005.

      Research and development expenses decreased 9% to $16.2 million in 2004 from $17.9 million in 2003. The decrease was primarily attributable to a reduction in our workforce and resulting decreases in salaries and related benefits and to a lesser extent, to reduced operating expenses as a result of our historical restructuring efforts. The decrease was offset, in part, by an increase in the use of off-shore developers.

      For 2005, 2004 and 2003, research and development expenses as a percentage of total revenues were 20%, 23% and 25%, respectively. We anticipate that research and development expenses will increase in 2006, but will remain consistent, as compared with 2005, as a percentage of total revenues.

      Sales and marketing expenses consist primarily of salaries, commissions and other related costs for sales and marketing personnel, travel, public relations, amortization of intangible assets and marketing materials and events.

      Sales and marketing expenses increased 1% to $30.0 million in 2005 from $29.6 million in 2004. The increase is primarily attributable to an increase of $808,000 during 2005 in the amortization expense related to an intangible asset for customer relationships from the Primus acquisition in November 2004. This increase was offset by cost saving initiatives that resulted in a reduction in the workforce of our sales and marketing groups, reduced recruitment fees and training costs, and a reduction in our spending on marketing programs along with a decrease in operating expenses resulting from our restructuring efforts.

      Sales and marketing expenses decreased 5% to $29.6 million in 2004 from $31.2 million in 2003. The decrease is primarily attributable to a reduction of our sales and marketing group, a reduction in our spending on marketing programs and a reduction in commissions from decreased product revenues. Compensation, commissions and benefits costs decreased by approximately $632,000 and marketing and promotional expenses decreased by approximately $1.2 million, with the remainder of the net decrease caused by a decrease in operating expenses resulting from our restructuring efforts. These decreases were offset in part by $559,000 of amortization of an intangible asset related to customer relationships from the Primus acquisition.

      For 2005, 2004 and 2003, sales and marketing expenses as a percentage of total revenues were 33%, 43% and 43%, respectively. We expect that sales and marketing expenses will remain consistent, as compared with 2005, as a percentage of total revenues. However sales and marketing expenses can fluctuate as a percentage of total revenues depending on economic conditions, program spending, the rate at which new sales personnel become productive and the level of revenue.

      General and administrative expenses consist primarily of salaries and other related costs for operations and finance employees and legal and accounting fees.

      General and administrative expenses increased 45% to $11.2 million in 2005 from $7.7 million in 2004. Approximately 55% of the increase was related to an increase in outside services and professional fees of approximately $1.9 million, with most of the remainder related to increases in insurance expenses of $320,000, recruiting fees of $128,000 and amortization of an intangible asset related to non-compete agreements from the Primus purchase of $111,000. Contributing to the increase in outside services of approximately $1.9 million for the year ended December 31, 2005 were costs associated with Sarbanes-Oxley compliance and the integration of the Primus acquisition.

      General and administrative expenses decreased 19% to $7.7 million in 2004 from $9.5 million in 2003. Approximately 52% of the decrease was related to a decrease in our workforce, 28% of the decrease was the result of lower hiring and training costs with the remainder related to decreases in rent expense and facilities related charges and other operating expenses resulting from our restructuring efforts and cost containment initiatives, offset by an increase in professional services comprising legal and accounting costs primarily due to compliance with the internal control requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

      For 2005, 2004 and 2003, general and administrative expenses as a percentage of total revenues were 12%, 11% and 13%, respectively. We anticipate that general and administrative expenses will decrease slightly, as compared with 2005, as a percentage of total revenues.

      During each of the last five years we have taken restructuring actions to realign our operating expenses and facilities with the requirements of our business and current market conditions. These actions have included closure and consolidation of excess facilities, reductions in the number of our employees, abandonment or disposal of tangible assets and settlement of contractual obligations. In connection with each of these actions we have recorded restructuring charges, based in part upon our estimates of the costs ultimately to be paid for the actions we have taken. When changes or circumstances result in changes in our estimates relating to our accrued restructuring costs, we reflect these changes as additional charges or benefits in the period in which the change of estimate occurs. For detailed information about our restructuring activities and related costs and accruals, see Note 10 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

      During 2005, we recorded a net restructuring charge of $885,000, consisting of $1.8 million of costs associated with the relocation of our San Francisco office and reduction of space we occupy in San Francisco and other facilities-related charges, which were partially offset by a net benefit of $932,000, resulting from the net favorable effect of changes of estimates relating to costs accrued in connection with our prior restructuring activities. The principal components of this $932,000 net benefit were a $792,000 reduction in estimated subleasing costs related to our 2001 restructuring actions, as a result of our re-evaluation of the financial condition of our subtenants and their ability to meet their financial obligations to us, and a $257,000 reduction in estimated facilities-related costs attributable to our 2004 restructuring actions, as a result of our execution of a sublease agreement for the vacated space. These favorable changes more than offset net unfavorable changes in estimates in the aggregate net amount of approximately $117,000 relating to our restructuring actions in various prior periods.

      In 2004, we recorded a net restructuring charge of $3.6 million, consisting of $1.5 million of facilities-related costs and $2.5 million of employee severance and benefits costs related to our 2004 restructuring actions, partially offset by $379,000 of net benefits resulting from changes in estimates relating primarily to our 2001, 2002 and 2003 facility related restructuring actions. The $1.5 million of facilities-related costs were primarily comprised of $800,000 for an operating lease related to idle office space net of assumptions for vacancy period and sublease income based on the then current real estate market data, $200,000 of leasehold improvements written down to their fair value and $500,000 of prepaid rent related to the abandoned space, which was recorded as part of prior lease settlements. The $2.5 million for severance and benefit costs related to cost reduction actions taken to terminate 56 employees or 14% of our worldwide employee base.

      In 2003, we recorded a net restructuring benefit of $10.5 million, consisting of charges of $1.5 million for facilities-related costs and $1.2 million for employee severance benefits costs related to restructuring actions in the second and third quarters of 2003, which were more than offset by $13.6 million of net benefits resulting from changes in estimates relating to prior restructuring actions, primarily consisting of a $11.5 million benefit attributable to the settlement during 2003 of our obligations relating to five leased premises vacated in connection with our 2001 restructuring actions and a $7.2 million benefit related to a lease vacated in connection with our 2002 restructuring. These benefits were offset by additional charges primarily for other leases of $2.8 million related to our 2001 action and $1.9 million related to our 2002 action. Other changes in estimates were recorded in 2003.

      As of December 31, 2005, we had an accrued restructuring liability of $5.1 million primarily for facility related costs. The long-term portion of the accrued restructuring liability was $2.1 million.

      At December 31, 2005, we had lease arrangements related to seven abandoned facilities from our restructuring actions. One of these leases is the subject of a lease settlement arrangement under which we are obligated to make payments through 2006. The lease agreements with respect to the other six facilities are ongoing. Of these locations, the restructuring accrual for the Reading, UK location is net of assumed sub-lease

income, as no sub-lease agreement had been executed by December 31, 2005. The restructuring accrual for all other locations is net of the contractual amounts due under an executed sub-lease agreement or there is no assumed sub-lease income included in the accrual. All locations for which we have recorded restructuring charges have been exited, and thus our plans with respect to these leases have been completed. A summary of the remaining facility locations and the timing of the remaining cash payments are as follows (in thousands):

      Interest and other income, net decreased 45% to $219,000 in 2005 from $395,000 in 2004. The decrease was primarily due to an increase in the foreign exchange loss of $420,000 for the year, offset by an increase in interest income of $161,000 and an increase in other income of $83,000.

      Interest and other income, net decreased 74% to $395,000 in 2004 from $1.5 million in 2003. The decrease was primarily due to a decrease in foreign currency related gains of $767,000 and decreased interest income due to lower balances of cash, cash equivalents and marketable securities. Included in interest and other income, net in 2004 and 2003 were gains of $18,000 and $785,000, respectively, from foreign currency exchange transactions and the re-measurement of foreign currency denominated assets and liabilities into the functional currency of the various subsidiaries.

      As a result of net operating losses incurred, and after evaluating our anticipated performance over our normal planning horizon, we have provided a full valuation allowance for our net operating loss carryforwards, research credit carryforwards and other net deferred tax assets. The tax provision recorded in 2005 relates to foreign taxes. During 2004 and 2003 we reversed previously accrued taxes of $158,000 and $332,000, respectively, for foreign locations due to the closure of statute of limitations, or as a result of changes in our estimates of potential amounts due in those locations.

Liquidity and Capital Resources

      Our capital requirements relate primarily to facilities, employee infrastructure and working capital requirements. Historically, we have funded our cash requirements primarily through the public and private sales of equity securities, and commercial credit facilities. More recently, we have been able to fund our cash requirements in part from operations. At February 28, 2006, we had $24.9 million in cash and cash equivalents and $8.3 million in marketable securities.

      Cash provided by operating activities was $3.9 million in 2005. This consisted primarily of net income of $5.8 million, depreciation and amortization of $4.2 million, a non-cash restructuring charge of $1.2 million and a decrease in accounts receivable of $3.0 million due to improved collection efforts, offset by payments of accrued restructuring costs of $6.1 million, a decrease in deferred revenues of $4.1 million and payments of accounts payable of $1.4 million.

      Cash used in operating activities was $14.1 million in 2004. This consisted primarily of a net loss of $9.5 million, an increase in accounts receivable of $7.1 million, a decrease in accrued restructuring of $6.8 million and a decrease in accrued expenses of $3.4 million offset by depreciation and amortization of $3.0 million, non-cash restructuring charges of $0.7 million, an increase in deferred revenue of $7.0 million, a decrease in prepaid expenses and other current assets and deferred rent of $1.6 million and an increase in accounts payable of $0.5 million.

      Our investing activities for 2005 used cash of $2.9 million and consisted primarily of the payment of acquisition related costs of $1.0 million, capital expenditures of $1.9 million for computer hardware, offset by a decrease in other assets of $0.3 million and net purchases of marketable securities of $0.3 million. Our investing activities for 2004 consisted primarily of capital expenditures of $0.8 million and net proceeds from maturities of marketable securities of $0.4 million, along with net cash acquired in the Primus acquisition of $2.7 million. Our lease in Cambridge expires in 2006 and we may find it beneficial to move our headquarters, creating a requirement for additional leasehold improvements. Therefore, we expect that capital expenditures, including the additional leasehold improvements, will total approximately $6.0 million in 2006.

      Net cash provided by financing activities was $1.5 million in 2005, representing proceeds from our employee stock purchase plan and the exercise of stock options aggregating $2.0 million, offset by principal payments on notes payable and capital leases aggregating $0.5 million. Net cash provided by financing activities was $1.0 million in 2004, consisting of proceeds from stock option exercises and our employee stock purchase plan of $1.5 million, offset by principal payments on notes payable of $0.5 million.

      Our accounts receivable balance and days sales outstanding, or DSO, as of December 31, 2005, 2004 and 2003 were as follows:

      The significant improvement in DSO as of December 31, 2005 compared to 2004 is due to the impact of acquiring Primus’ accounts receivable balance late in 2004 with only two months of Primus’ revenues in 2004 to offset the accounts receivable and product license deals that closed before year end but were not recognized into revenue during 2004.

      We have a $20 million revolving line of credit with Silicon Valley Bank (the Bank) which provides for borrowings of up to $20 million. The line of credit bears interest at the Bank’s prime rate (7.25% at December 31, 2005). The line of credit is secured by all of our tangible and intangible intellectual and personal property and is subject to financial covenants including liquidity coverage and profitability. The credit facility required net profitability of at least $1.00 for the fourth quarter of 2005.

      In February 2006, we entered into the Ninth Loan Modification Agreement (the Ninth Amendment), which amended the Amended and Restated Loan and Security Agreement dated as of June 13, 2002. Under the Ninth Amendment, the profitability covenant was revised to require net income of at least $1.00 for the

quarter ending March 31, 2006 and net income of at least $500,000 for the quarter ended June 30, 2006 and for each quarter thereafter through the duration of the credit facility. Our ability to meet these profitability covenants may be affected by our adoption of SFAS 123R, effective January 1, 2006. We estimate that stock based compensation expense related to share-based payments to employees will have an impact of at least $3.0 million to $4.0 million on fiscal 2006 results related to the unvested portion of options granted prior to January 1, 2006, options granted after December 31, 2005 and Employee Stock Purchase Plan transactions after December 31, 2005. This estimate is based on our current level of employees and related unvested stock options, expected level of employees and stock options to be granted in 2006, and participation in our employee stock purchase plan. We are also required to maintain unrestricted and unencumbered cash, which includes cash equivalents and marketable securities, of greater than $20.0 million at the end of each month through the duration of the credit facility

      To avoid additional bank fees and expenses, we are required to maintain unrestricted cash, which includes cash equivalents and marketable securities, at the Bank in an amount equal to two times the amount of obligations outstanding, which includes letters of credit that have been issued but not drawn upon, under the loan agreement. In the event our cash balances at the Bank fall below this amount, we will be required to pay fees and expenses to compensate the Bank for lost income. At December 31, 2005, we were in compliance with all related financial covenants. In the event that we do not comply with the financial covenants within the line of credit or defaults on any of its provisions, the Bank’s significant remedies include: (1) declaring all obligations immediately due and payable, which could include requiring us to cash collateralize our outstanding Letters of Credit (LCs); (2) ceasing to advance money or extend credit for our benefit; (3) applying to the obligations any balances and deposits held by us or any amount held by the Bank owing to or for the credit of our account; and, (4) putting a hold on any deposit account held as collateral. If the agreement expires, is not extended, the Bank will require outstanding LCs at that time to be cash secured on terms acceptable to the Bank. The revolving line of credit, as amended, expires on January 31, 2008.

      While there were no outstanding borrowings under the facility at December 31, 2005, the bank had issued LCs totaling $6.1 million on our behalf, which are supported by this facility. The LCs have been issued in favor of various landlords to secure obligations under our facility leases pursuant to leases expiring through January 2009. The line of credit bears interest at the Bank’s prime rate (7.25% at December 31, 2005). As of December 31, 2005, approximately $13.9 million was available under the facility.

      At December 31, 2005 our contractual cash obligations were as follows:

      Of the $12.1 million in future minimum lease payments, $8.8 million is included in the Company’s accrued restructuring charges. The $8.8 million was reduced to $4.9 million restructuring charge after taking into consideration estimated sublease income, contracted sublease income, vacancy periods and operating costs of the various subleased properties.

      We believe that there will not be any material real estate lease settlements beyond those completed to date. As such, we believe that our balance of $33.6 million in cash and cash equivalents and marketable securities at December 31, 2005, along with other working capital and cash expected to be generated by our operations will allow us to meet our liquidity needs over the next twelve months. However, our actual cash requirements will depend on many factors, including particularly, overall economic conditions both domestically and abroad. We may seek additional external funds through public or private securities offerings,

strategic alliances or other financing sources. There can be no assurance that if we seek external funding, it will be available on favorable terms, if at all.

Recent Accounting Pronouncements

      On December 16, 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment, (SFAS 123(R)). SFAS 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant. Pro forma disclosure is no longer an alternative.

      SFAS 123(R) permits companies to adopt its requirements using one of two methods. A “modified prospective” method recognizes compensation cost beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. A “modified retrospective” method includes the requirements of the modified prospective method described above, but also permits entities to restate their historical financial statements based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either (a) for all prior periods presented or (b) for prior interim periods of the year of adoption.

      As permitted by SFAS 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R) will have a significant impact on our results of operations, although it will have no impact on our overall financial position. SFAS 123(R) is required to be adopted effective at the beginning of the first quarter of fiscal 2006. We will adopt SFAS 123(R) in fiscal year 2006 on January 1, 2006 using the modified prospective method. We estimate that the stock based compensation expense related to share-based payments to employees will have an impact of at least $3.0 million to $4.0 million on fiscal 2006 results related to the unvested portion of options granted prior to January 1, 2006, options granted after December 31, 2005 and Employee Stock Purchase Plan transactions after December 31, 2005. This estimate is based on our current level of employees and related unvested stock options, expected level of employees and stock options to be granted in 2006, and participation in our employee stock purchase plan in 2006.

      We maintain an investment portfolio consisting mainly of investment grade money market funds, corporate obligations and government obligations with a weighted average maturity of less than one year. These held-to-maturity securities are subject to interest rate risk. However, a 10% change in interest rates would not have a material impact to the fair values of these securities primarily due to their short maturity and our intent to hold the securities to maturity. There have been no significant changes since December 31, 2005.

      The majority of our operations are based in the U.S., and accordingly, the majority of our transactions are denominated in U.S. dollars. However, we have foreign-based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of foreign currencies. Our primary foreign currency exposures relate to our short-term intercompany balances with our foreign subsidiaries and accounts receivable valued in the United Kingdom in U.S. dollars. Our primary foreign subsidiaries have functional currencies denominated in the British pound and Euro, and foreign denominated assets and liabilities are remeasured each reporting period with any exchange gains and losses recorded in our consolidated statements of operations. Based on currency exposures existing at December 31, 2005, a 10% movement in foreign exchange rates would not expose us to significant gains or losses in earnings or cash flows. We may use derivative instruments to manage the risk of exchange rate fluctuations. However, at December 31, 2005, we had no outstanding derivative instruments. We do not use derivative instruments for trading or speculative purposes.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Art Technology Group, Inc.

      We have audited the accompanying consolidated balance sheets of Art Technology Group, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Art Technology Group, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Art Technology Group, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006 expressed an unqualified opinion thereon.

Boston, Massachusetts

March 9, 2006

ART TECHNOLOGY GROUP, INC.

CONSOLIDATED BALANCE SHEETS

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

ART TECHNOLOGY GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

ART TECHNOLOGY GROUP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME (LOSS)

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

ART TECHNOLOGY GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS